Bank of England Is Set to Raise Rates After U.K. Political Turmoil

Having barely recovered from the pandemic, Britain’s economic growth is faltering again as rising energy bills, food costs and mortgage rates squeeze consumer spending, stalling one of the key drivers of the country’s economy.

The bank forecast that the economy would shrink by 0.75 percent in the second half of 2022, and would keep falling next year and the first half of 2024 because of high energy prices and “materially” tighter financial conditions, including higher home mortgage rates and borrowing costs for companies. This two-year recession is based on the assumption that the central bank raises interest rates in line with market expectations. While the bank has pushed back on those expectations, it said that even if interest rates didn’t rise again the economy was still set to record a decline for the second half of this year and much of next year.

This outlook could temper how much higher the bank raises rates. That’s because it takes time for rate changes to have an impact on the economy, and that impact is likely to hit Britain while it is in a recession, when households and businesses are least able to bear the additional economic pain.

This lag is a challenge for many central banks, which are also raising interest rates quickly in the face of the highest inflation in decades and potential recessions. On Wednesday, the Federal Reserve raised rates by three-quarters of a percent and signaled that more increases were to come, though the pace of them would slow. Last week, the European Central Bank raised rates by three-quarters of a point as it said inflation could increase, but the bank heavily stressed that the economy was weakening.

In Britain, there have been “significant developments” in fiscal policy since the bank’s last policy meeting six weeks ago, Thursday’s statement said. The day after the previous meeting, on Sept. 23., Ms. Truss’s finance minister, Kwasi Kwarteng, announced a series of unfunded tax cuts that provoked turmoil in the government bond market and set Britain’s fiscal policy on a collision course with the bank’s monetary policy.

At the time, the central bank said it would need to have a “significant” response as it expected the tax cut and spending plan to add to inflationary pressures. Meanwhile, in another corner of the bank, officials intervened in the bond market, fearing for the country’s financial stability.

Two weeks ago, Ms. Truss resigned, and her successor, Rishi Sunak, has made it clear that he intends to take a different approach to public finances. Later this month, he and the chancellor of the Exchequer, Jeremy Hunt, are expected to announce tax increases and spending cuts alongside a plan to cut Britain’s debt levels.