Recession looms larger after BoE decision

4 August 2022

The Bank of England has increased interest rates by 0.5% to 1.75%, its biggest increase in 27 years as it battles to curb rising inflation. It marks the sixth consecutive hike from the Bank since December. The central bank also has warned that the UK economy will enter recession in the final three months of this year.

In a bleak outlook, the Bank’s Monetary Policy Committee said inflationary pressures in the UK have “intensified significantly” since the Committee’s previous meeting, driven largely by a near doubling in wholesale gas prices since May.

Inflation is now expected to reach 13% in the fourth quarter, from 9.4% in June and remain at elevated levels throughout much of 2023.

David Goebel, associate director of investment strategy at Evelyn Partners, said: “The accompanying inflation report and economic estimates paint a more difficult period ahead for the UK economy than the MPC had previously anticipated.

Although the 9.4% June inflation print was driven by external factors, mainly global energy prices, this rate move signals the Bank is also concerned with domestic sources of inflation like wage growth. Continuing weakness in sterling, which has depreciated by around 10% year-to-date relative to the US dollar, increases the risk of further inflationary pressure.

“However, policymakers are balancing this with concerns over weakness in the economy – demand in the UK labour market is easing, and energy prices are set to rise by as much as 70% in the autumn, when Ofgem’s next price cap comes into play. Softening consumer confidence points to weaker spending in the second half of this year, so declining growth could go some way to curtailing high levels of inflation in itself.”

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said the UK must brace itself for “tough times ahead.”

The interest rate hike will affect both borrowers and savers, with homeowners on tracker mortgages set to face higher payments with immediate effect.

Morrissey said: “The interest rate increase has big impacts for our finances. Mortgage holders who are yet to fix their rates as well as those trying to repay other debt who will see their repayments climb. However, savers and people coming up to retirement may be able to find some slightly more positive news among the gloom.”

According to Morrissey, someone with a £300,000, 25-year repayment mortgage on the average SVR could see their monthly payments go up by over £88 a month.

However, pension savers are set to benefit from the rate hike. Annuity incomes have surged recently with a 65 year old with a £100,000 pension able to get an income of £6,225 per  year, compared to just under £5,000 this time last year.

According to Morrissey: “Interest rates are just one factor contributing to annuity incomes, but today’s increase could fuel a further boost over the coming months. Annuities fell out of favour with the advent of pension flexibilities with many people seeing them as inflexible and offering poor value.

These increases could see more people consider including them as part of their retirement income strategy.”

Data from Hargreaves Lansdown found more than half of people who envisage buying an annuity would do so if their income reached £6,500.

Meanwhile, Nigel Green, founder of deVere Group, urged investors to revise their portfolios in response to the Bank of England’s announcement.

Green said: “The Bank of England’s flagging-up of a full-on recession comes at the same time the UK is experiencing a 42-year high rate of inflation.This means the spectre of stagflation is drawing near. Stagflation can be viewed as a worst of both worlds scenario.

“In such times as these, investors tend to move away from riskier assets and towards perceived safe assets. But this also needs to be considered carefully.”

While cash is often considered a safe haven during periods of volatility, Green says rampant inflation means excess cash will lead to losses in real value.

Green added: “A considered mix of asset classes, sectors, regions and currencies offers protection from market shocks. A good fund manager will help investors capitalise on the opportunities that volatility brings and sidestep potential risks as and when they are presented.

“Investors would do well to review their portfolios now to ensure they are well positioned.”

Professional Paraplanner