Households face the longest and deepest fall in living standards on record as energy bills triple and the UK plunges into a deep and protracted recession, the Bank of England has warned, in one of its bleakest ever assessments of the economy.
The cost-of-living crisis will continue throughout next year and only begin to ease in 2024, with the UK economy contracting for fice consecutive quarters, according to the Bank’s latest forecasts.
Inflation is set to surge to 13.3 per cent this winter when soaring gas prices mean that consumers face average energy bills of £3,500 – up from £1,200 a year ago – the Bank said.
The inflation forecast was up sharply from the 9.4 per cent predicted just two months ago, with prices now on track to continue rising rapidly throughout 2023.
The Bank’s Monetary Policy Committee (MPC) warned that there was “exceptionally large” risk around its latest projections, and the situation could deteriorate further if gas prices move higher still.
That is a scenario that analysts believe is becoming more likely after Russia cut back supplies to Europe last month and governments across the continent began to ration supplies.
It expects the economy to continue to shrink all the way through next year, with the spending power of household incomes plunging by almost 5 per cent as prices outpace wages.
It would be the biggest fall in living standards since the Bank began collating comparable figures in 1960. It would also mean that real earnings in 2024 remain below the level they reached in 2007, marking an unprecedented period of stagnation punctuated by multiple crises.
Acute labour shortages will mean firms continue to offer higher wages to recruit skilled staff, but this will be dwarfed by the rising cost of living, driven by energy costs.
Average pay rises will jump to 6 per cent – less than half the peak rate of inflation.
Even after the economy begins to grow, further pain lies in store, with unemployment set to climb from 3.8 per cent to 6.3 per cent in 2025.
Despite the bleak outlook, the Bank’s nine-member Monetary Policy Committee voted eight to one in favour of hiking interest rates by 0.5 percentage points to 1.75 per cent – the highest since the Global Financial Crisis in January 2009.
It is hoped the move will tame out-of-control price rises but it also means millions of homeowners will face rising mortgage payments, with the average rate on course to climb to 3.5 per cent.
Overall, the economy is expected to shrink by 2.1 per cent, meaning the recession will be of comparable scale to those of the early 1990s and 1980s, the Bank said.
When the country emerges from recession in 2024, the Bank expects growth to remain close to zero throughout the following year.
The massive increase in inflation will also hammer the public finances, adding billions to the pile of government debt and to interest payments on bonds which are indexed to inflation.
The dire figures will cause concern for Liz Truss, who is favourite to become the next prime minister.
Ms Truss has pledged to slash taxes by billions in a bid to win over Conservative party members. Her opponent in the Tory leadership race, Rishi Sunak, has attacked the plan as being fiscally irresponsible.
Neither candidate has laid out detailed plans for how they would support families struggling through a rapidly worsening cost-of-living crisis.
Responding to the economic forecasts, Labour’s shadow chancellor Rachel Reeves, said: “This is further proof that the Conservatives have lost control of the economy, with skyrocketing inflation set to continue, while mortgage and borrowing rates continue to rise.
“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.”
Among the first people to be impacted by rising interest rates will be the 20 per cent of homeowners on variable or tracker mortgages who will see their monthly payments rise immediately.
First-time buyers and people whose current mortgage deals are soon to expire will also pay more.
Someone who took out a mortgage worth £250,000 over 25 years at around 1 per cent would pay roughly £942 per month. After today’s rise to 1.7 per cent, someone borrowing the same amount but at 1.7 per cent would pay £1,029 per month.
Energy price rises will have a much larger impact on people’s disposable incomes, however. Speaking after the MPC’s report was published, deputy governor Ben Broadbent said
Andrew Bailey, the Bank’s governor said persistent inflation would be “even worse” if interest rates were not increased and that lower-income households would be hardest hit.