The UK economy will be plunged into recession for more than a year this autumn as rising energy prices push inflation above 13%, the Bank of England has warned.

In a bleak outlook for consumers and business, the Bank forecast five quarters of economic contraction and a 5% fall in real-terms living standards, and increased interest rates by 0.5 percentage points, the largest single rise in 28 years.

The Bank’s baseline forecast is for GDP to fall by 1.25% in 2023 and 0.25% in 2024, the first instance of two years of annual economic contraction since the 1960s.

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The Bank’s Monetary Policy Committee voted 8-1 to increase the base rate to 1.75%, an attempt to prevent the inflationary impact of soaring energy prices being compounded by domestic price and wage pressures.

The interest rate increase will add around £650 to annual repayments for those with an average tracker mortgage. The increase in monthly tracker repayments for homeowners since rates began rising from a low of 0.1% last December is around £170.

The savage inflation rate, the highest since September 1980, is being driven by the rising cost of wholesale gas on international markets, which has doubled since May and is on course to treble domestic energy bills.

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The Bank believes that the domestic energy price cap will reach £3,500 per household in October, prompting inflation to peak at 13.3% in the fourth quarter of this year and remain above 10% until the middle of next year. It’s forecast to fall back marginally to 9.5% in the third quarter and 5.5% by the end of the 2023.

The domestic energy price cap is expected to increase again when regulator Ofgem reviews the figure in January, but the MPC believes the inflationary impact will be offset by falls in other areas. It says goods price inflation may have peaked, and commodity prices are already beginning to fall back.

Real living standards to fall, despite support for energy costs

Real living standards, even after the impact of direct government support for energy bills of at least £400 per-bill payer, are forecast to fall by 1.5% this year and 2.25% next year, with a 5% decline from peak to trough.

A five-quarter recession ending in the first quarter of 2024 would be comparable in length to the downturns of 2007-08, the early 1990s and the early 1980s, but would be shallower than the financial crisis with a peak-to-trough decline in GDP of 2.1%.

The Bank’s Monetary Policy Committee said energy prices are responsible for the majority of the rise in inflation, with continued Covid supply chain disruption the other significant factor.

Wages to rise but recession could result in higher unemployment

The tight domestic labour market, which currently features more vacancies than job-seeking unemployed, is also a factor.

The MPC forecast that wages will rise 6% this year as employers battle to recruit and retain staff, but warned that as the recession bites unemployment could begin to rise next year from the current 3.8%, peaking at 5.5%.

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Explaining its reasoning for the rate increase, the minutes of an MPC meeting said: “The United Kingdom is now projected to enter recession from the fourth quarter of this year. Real household post-tax income is projected to fall sharply in 2022 and 2023 while consumption turns negative.

“The labour market remains tight, and domestic cost and price pressures are elevated. There is a risk that a longer period of externally generated price inflation will lead to more enduring domestic price and wage pressures.

“In view of these considerations, the committee voted to increase the Bank Rate by 0.5 percentage points, to 1.75%.”

‘Proof the Tories have lost control of the economy’

Rachel Reeves, shadow chancellor, said the forecast was “further proof that the Conservatives have lost control of the economy”.

“As families and pensioners worry about how they’re going to pay their bills, the Tory leadership candidates are touring the country announcing unworkable policies that will do nothing to help people get through this crisis.

“Labour would help households right now by removing the tax breaks that are subsidising oil and gas producers and using that money to help people now, including by cutting VAT on energy bills.

“And with our Climate Investment Pledge and plan to buy, make and sell more in Britain, a Labour government will build the strong, secure and fair economy we need.”

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