Bank of England warns of recession risk in run-up to expected election next year

The Bank of England has warned the economy will be on the brink of recession in an election year after signalling interest rates will need to remain high for an extended period to tackle stubborn inflationary pressures.

After holding rates unchanged at 5.25% for a second consecutive time – the highest level since the 2008 financial crisis – Threadneedle Street said the risks from war in the Middle East and domestic inflationary pressures would force it to keep borrowing costs high despite a worsening growth outlook.

“It’s much too early to be thinking about rate cuts,” said Andrew Bailey, the Bank’s governor. “Higher interest rates are working and inflation is falling. But we need to see inflation continuing to fall all the way to our 2% target. We’ve held rates unchanged this month but we will be watching closely to see if further rate increases are needed.”

Issuing updated forecasts as Rishi Sunak’s government comes under growing pressure over his economic management in the run-up to an election expected next year, the central bank said it anticipated flatlining growth throughout 2024.

Giving a 50-50 chance of a recession by the middle of next year – beginning around the time a spring election could be held – it forecast four consecutive quarters of zero growth in gross domestic product (GDP), should interest rates follow the path expected by financial markets.

City investors expect a cut in rates next autumn as households and businesses come under pressure from previous increases. However, if borrowing costs were held at current levels, the Bank forecast a recession could be under way by the summer. Economists regard two quarters of falling GDP as the technical definition of recession. The Bank estimates that at best, the UK economy will not grow at all in 2024.

The Bank’s monetary policy committee voted by a majority of six to three to keep rates on hold, with a minority – the external members Catherine Mann, Megan Greene and Jonathan Haskel – pushing to restart the toughest cycle of rate increases in decades by calling for a quarter-point rise.

Financial markets had widely expected a hold decision as Britain’s economy comes under increasing pressure from 14 consecutive rises from a record low of 0.1% in December 2021. It comes after similar decisions from the US Federal Reserve and the European Central Bank.

Inflation in the UK remained at 6.7% in September after a sharp rise in fuel costs for motorists in recent months offset weaker growth in the cost of a weekly food shop. Britain has the highest inflation rate among the G7 group of advanced economies.

Threadneedle Street said it expected the full impact of previous rate increases feeding through to the economy would help to bring inflation down to about 4.75% by the fourth quarter of 2023 – meaning Sunak would narrowly meet his pledge to halve the inflation rate this year from 10.7% at the end of last year.

However, it would take time for the full impact of its previous increases to be felt, as millions of mortgage holders approach the end of cheaper deals purchased before the surge in borrowing costs – with 2 million expected to refinance this year and next.

With about half of the impact on households and businesses still to come, the Bank said interest rates would probably need to be kept “restrictive for an extended period of time”, and warned there was a danger that further rate increases could be needed if inflationary pressures proved stronger than anticipated.

Forecasting a drop in the inflation rate back to the 2% target set out by the government by the end of 2025, the central bank warned rising energy prices amid the war between Israel and Hamas had potential to add to inflationary pressures.

It also warned that evidence of stronger pay growth and price rises in the services sector of the economy could fuel persistently higher levels of inflation, as the impact from last year’s surge in energy prices after the Russian invasion of Ukraine gradually fades.