Warning of UK economy downturn as interest rates rise

GBP

Sterling fell by approximately 2% against both the euro and US dollar on Thursday as the Bank of England warned of a recession and that inflation could peak at 10% by the end of this year.

Policymakers opted to hike interest rates in the UK by 25 basis points, taking the main lending rate from 0.75% to 1% – its highest level since 2009 and the fourth consecutive hike since December. Policymakers were split on the vote with three of the nine-strong voting committee siding for a larger 0.5% percentage hike to combat a thirty-year high inflation.

Typically, a voting pattern which shows policymakers voting for a greater rate hike is interpreted as hawkish and in normal circumstances would cause Sterling to rally. However, with inflation sitting at record highs and further inflationary pressures present in the global economy – such as continuous lockdowns in China and the conflict in Ukraine – there are fears that higher inflation may become embedded in the UK economy.

Markets were particularly concerned with the economic projections given by the BoE. Whilst economic growth projections for this year remained at 3.75%, the BoE slashed its forecast for 2023 to show a contraction of 0.25%. Growth projection for 2024 is also expected to shrink to 0.25% from a previous 1%.

Inflation forecasts were increased from an estimate of 8% to 10% by year-end, and policymakers warned that unemployment could surge to 5.5% as companies look to reduce costs amidst increasing price pressures.

Sterling traders are keeping a close eye on today’s results of local elections. According to estimates, the Conservatives are projected to lose up to a third of its local council seats in Britain, a development which would place the current Prime Minister under considerable pressure to resign.

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