The bank of england warned Kwasi Kwarteng that the economy is in recession and will most likely have to raise interest rates after Friday’s mini-budget tax cut.
On the eve of a major support package from the Chancellor designed to break what he called the economy’s ‘stagnation cycle’, Threadneedle Street said the UK economy was heading for a second consecutive quarter of declines production, with gross domestic product expected to contract. 0.1% in the three months ending in September.
However, with energy and food bills continuing to soar and inflation not expected to peak until October, the Bank of England has raised the cost of borrowing for a seventh consecutive meeting of its monetary policy committee ( MPC) and made it clear that the new government’s plans risked triggering more interest rate hikes.
The MPC – which raise interest rates by 0.5 percentage points at 2.25% on Thursday – said he would carefully assess the impact of energy price caps and the government’s growth plan ahead of the committee’s next decision in November.
In a letter to the Chancellor explaining why inflation is nearly five times its 2% target, Bank Governor Andrew Bailey said: “While the outlook suggests more persistent inflationary pressures, notably due to a stronger demand, the committee will react with force, if necessary.”
Kwarteng will announce 30 separate measures on Friday – including tax cuts, new investment zones and an acceleration of infrastructure projects – in a bid to boost the economy’s growth rate to its stated target of 2 .5% per year.
One of the main elements of the package – the cancellation of £13billion of the National Insurance contribution hike, introduced in April to fund the Health and Social Care Levy – will come into force on November 6 , three days after the next Bank interest rate decision.
While nearly 28million people will keep more of their income following the move, the Resolution Foundation think tank said on average the poorest 10% of households would earn £11.41 in 2022-23, while the top 10% of households would earn £682.
The mini-budget is expected to contain other important interventions to boost growth beyond the reversal of the NIC hike and the planned corporate tax hike next April, Treasury sources confirmed. , a Whitehall source describing the package as having “more bunnies than Watership Down”.
One of the key elements of the tax event will be new investment zones for 38 local and municipal authorities in England – including West Midlands, Tees Valley, Somerset and Hull – which will have major planning deregulation to free up more land for housing and commercial development; and tax reductions for businesses.
The investment zone plans include a number of controversial measures such as removing the need for developers to meet affordable housing targets, as first revealed by the Guardian. Environmental regulations will also be reduced in these areas.
Kwarteng will defend plans to lift the cap on bankers’ bonuses and a ban on fracking, saying the government will be “bold and unashamed in the pursuit of growth – even if it means making tough decisions”.
He will also announce measures to speed up the delivery of about 100 major infrastructure projects across the country that he will say have been unnecessarily delayed by bureaucracy.
The Chancellor will tell MPs: ‘Growth is not as high as it should be, which has made it harder to pay for public services, necessitating higher taxes. This cycle of stagnation has caused the tax burden to reach the highest levels since the late 1940s.
“We are determined to break this cycle. We need a new approach for a new era of growth. This is how we will provide higher wages, better opportunities and enough income to fund our public services, now and in the future.
“This is how we will successfully compete with dynamic economies around the world. This is how we will transform the vicious circle of stagnation into a virtuous circle of growth.
Pat McFadden, the shadow chief secretary to the Treasury, said the sums involved were extraordinary without any consideration of how they would be funded other than by borrowing.
“Their choice to fund all of this with borrowing and not attempt to fund even part of it through a windfall tax on energy companies making the most of the current crisis increases the risk and let UK taxpayers pay longer,” he said.
Announcing its latest interest rate decision, the Bank of England said the energy price guarantee, which caps household bills, would mean inflation would peak at just below 11% this autumn rather than exceeding 13%. Although the consumer price index fell slightly from 10.1% in July to 9.9% in August, it remains at a level not seen since the early 1980s.
However, Bailey said in his letter to Kwarteng that government support measures risked adding to upward pressure on the cost of living. “All things being equal…this will add to medium-term inflationary pressures,” Bailey wrote.
After GDP fell 0.1% in the three months to June, the Bank said a further decline of 0.1% could now be expected in the third quarter amid a collapse in government spending. consumption and slower activity in the manufacturing and construction sectors.
He said the fall also reflected a weaker-than-expected rebound from the Queen’s additional Platinum Jubilee bank holiday, as well as the impact of businesses closing as a sign of respect for the state funeral this week. An economy is technically in recession if it experiences two successive quarters of negative growth.
Susannah Streeter, senior investment and market analyst at Hargreaves Lansdown, said: “The kickoff has been given in the economic tug of war between the Bank of England and the government of Liz Truss.
“The Bailey team at the Bank of England want to extract demand from the economy, to try and stop the price spiral, while the Truss team want to stimulate it, risking prolonging the pace of rate hikes. “