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Jeremy Hunt has pledged to resist calls to cut taxes as interest rates hit a 15-year high of 4 per cent.
In a move that will add nearly £50 a month to the average borrower’s mortgage payment, the Bank of England increased the rate of interest for the tenth consecutive time as part of efforts to bring down inflation.
But it said it thought it likely that inflation had peaked, adding that the economy had proved more resilient than expected in light of the cost of living crisis.
The Bank said the impending recession was now expected to be shorter and shallower than previously thought.
Responding to the Bank’s decision, the chancellor in effect ruled out tax cuts in his budget next month, saying the government needed to “support” the interest rate rise by not making decisions that could make it harder to bring down inflation.
“We recognise it is very difficult for families, businesses, up and down the country when interest rates go up,” Hunt said. “But much harder for them would be if we didn’t take decisive steps to bring down inflation. That’s why the Bank of England is absolutely right to do what they’ve done today.
“And we in the government must make sure we support them in what I do in the budget, to make sure that we make it easier, not harder, for them to do what we all want to do, which is to halve inflation.”
The consumer prices index, the main measure of inflation, fell from a 41-year high of 11.1 per cent last October to 10.5 per cent by the end of the year and is expected to decline further this year. However, it remains at more than five times the Bank of England’s target of 2 per cent.
The UK is suffering its worst bout of inflation in a generation because of soaring global energy prices, the war in Ukraine, Covid and Brexit.
Raising interest rates pushes up the cost of borrowing and offers a higher return on saving, encouraging people to save rather than spend. The aim is to reduce demand in the economy and bring down prices as a result.
The Bank said inflation was likely to “fall sharply” over the year, following the drop in natural gas prices. However, it added that the jobs market remained strong and growth in private sector wages higher than expected, suggesting inflation may be more persistent.
Its monetary policy committee issued a more upbeat assessment of the general state of the economy, saying it had shown “signs of greater resilience”. Output, as measured by gross domestic product, rose unexpectedly in November.
The Bank believes that although the economy narrowly avoided a technical recession then, it will meet the criteria — of GDP falling in two successive quarters — by the middle of this year. The UK economy is set to contract by 0.5 per cent, down from the Bank’s forecast in November of 1.5 per cent.
The recession is expected to last into the first three months of next year.The latest report is significantly less gloomy than the Bank’s previous forecast of nearly two years of contraction.