The Dilemma Of The Bank Of England

The UK is witnessing the highest annual inflation rate since 1982 at 9.4% in June surpassing the Bank’s target of 2%, and it is expected that inflation will pass 13 % by Q4 2022 and remain very elevated for around a year due to the high energy prices led by the Russian war at Ukraine, meaning that what you used to buy last year for £100 is now worth £109.4  with increasing rates. Moreover, fuel bills are expected to further increase by about 75% in October compared to the 40% expected increase in the May Report. However, it is expected to reach the 2% target by 2024, as seen below.

Figures 1 and 2 show the annual inflation rate in the UK from 1991-2025| Source: Bank of England (BOE)


Also, the Annual GDP growth, which is 0.8% QoQ and 8.7% YoY, is expected to reach -0.2% QoQ in Q2 and decrease over the next year and it is expected to witness a recession starting from Q4 as consumption growth becomes negative, as seen in the below graph. The OECD predicts that UK growth would be the weakest in the G20 in 2023 with the exception of Russia. Businesses in the UK are not only suffering from high costs but also from unfilled vacancies burdening them further to pay higher wages to attract candidates. The labor market is also suffering from a historical number of vacancies with higher wages, and unemployment is expected to increase in 2023.

Figure 3 |Source: Bank of England (BOE), Bloomberg


To combat such skyrocketing figures, the Bank of England (BOE) has decided on two of the main monetary policy instruments, interest rates (also called Bank Rate or  Base Rate) and the sale of government bonds (also called Gilts). The bank has unleashed the highest increase of 0.5% in interest rates since 1995 to reach 1.75% from 0.1% in December 2021. It is expected that the Bank rate will reach 3% in Q2 2023 before it falls back to 2.2% in Q3 2025. Also, depending on the state of the market at the time, the Bank aims to launch its programme of corporate bond sales starting on September 19, 2022.

Figure 4 shows the impact of Monetary Policy tools on Decreasing Inflation


Many figures will be released next week that will determine the next steps by the BOE as uncertainty and vagueness cloud the market including GDP growth rate, unemployment, inflation rates, and consumer confidence. Not only economic uncertainty is clouding the UK, but also the stepping down of Prime Minister Boris Johnson and the appointment of a new prime minister on September 5th is another chaotic issue. Economic and Political uncertainty could not only adversely affect the UK’s economic growth, but also the effect could creep into the financial markets with increased long-term borrowing costs and higher volatility in the UK equity and money markets for as long as 20 months, as well as drop in the currency’s value.


However, the most recent drop in the value of sterling against the dollar in July 2022 of 13% lower than a year ago, and 10.5% lower than the two-year average is more likely due to concerns about the UK economy's deterioration. The risk of the UK entering a recession, as recently projected by policymakers at the Bank of England, has been a far more powerful impact on sterling than uncertainty unlike the uncertainty that accompanied the Brexit and the beginning of the pandemic, as shown in the below figure.


Figure 5 shows the limited effect of uncertainty in economic policy on the GBP.  Source: Milas, C. (2022). UK political resignations: the current uncertainty could affect the economy for nearly two years.






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