By Fatma Younis
The Bank of England has raised interest rates to 4%, a 0.25 percentage point increase that arrives during a second cost of living crisis in four years. The decision leaves many households incredulous as they see little sign of a booming economy in their neighbourhoods.
Economic Resilience and Inflation Concerns
Official figures show the economy has proved resilient against the jump in oil and gas prices following the outbreak of war in Iran. However, UK high streets are struggling and the underlying drivers of inflation remain absent, with most households spending simply to stand still on essentials such as food, energy and leisure.
Diverging Forecasts: Bank vs OBR
The Bank’s policymakers believe the energy price shock, larger than first estimated, will surge through the economy, forcing up prices and triggering wage demands that could give inflation a second burst next year and the year after. This contrasts sharply with the Office for Budget Responsibility (OBR), which told parliament there is little impetus for strong wage growth. The OBR expects the economy to expand by just 1% in 2027 with consumer price inflation peaking at 3.75%, compared with the Bank’s projections of 1.6% growth and 4.9% inflation. Inflation stood at 3.5% in September.
Business Margins and Wage Growth
OBR chief economist David Miles said UK businesses are quite weak, having absorbed a large slice of rising energy and fuel costs. Profit margins have fallen from an average of 13-14% to 10-11%, leaving little appetite for high wage settlements and an imperative to rebuild margins.
Contrast with 2022 Crisis
The current situation differs markedly from the 2022 crisis when households held lockdown savings and firms competed fiercely for workers. Today, savings are low and households bear the scars of four years of high inflation. Retail, hospitality, transport and the charity sector are suffering, while even better-performing sectors like banking and oil and gas show little appetite for big wage increases. Vacancies are low, indicating firms have no need to hire more staff.
Policy Implications
The Bank’s own surveys indicate wage and price expectations have moved little since September, yet policymakers judge that responses to their business review will prove inaccurate and wages will jump. They see a risk that wage settlements will exceed business expectations. With the government constrained by bond markets, Chancellor John Healey is set to restrict borrowing and adhere to fiscal rules, while the Bank prepares to crack down on inflationary pressures it believes are coming.
