Bank of England warns UK faces

stagnating economy as it keeps rates

at 5.25%
The Bank of England said the UK faces a stagnating economy and persistent

inflation, as it kept interest rates at a 15-year high and warned that policy will stay

tight “for an extended period of time”. On a day that the BoE voted to hold rates at

5.25 per cent for the second successive meeting, its forecast highlights the challenge

for the UK economy and for Prime Minister Rishi Sunak as he heads into an election

year. The central bank said growth would remain “well below historical averages”

over the medium term, even as its forecasts signalled that inflation is set to remain

more persistent than it previously expected. BoE governor Andrew Bailey said the

Monetary Policy Committee would be watching “closely” to see if further rate rises

were needed, adding: “It’s much too early to be thinking about rate cuts.” The MPC

voted six to three to keep its benchmark rate unchanged, in line with expectations. A

minority of members sought a further quarter-point increase. The central bank is

treading a delicate line as it seeks to beat inflation while not pushing a weakening UK

economy into an outright recession in 2024, expected to be an election year. UK

interest rates are at their highest since the financial crisis, with the bank weighing

evidence of weak growth against consumer price inflation of 6.7 per cent. The BoE

now expects growth to be flat in the third quarter, weaker than previously expected,

with only a 0.1 per cent expansion in the final three months of the year. It anticipates

that output will remain stagnant throughout 2024, with a significant risk of outright

contraction. The downbeat picture reflects the pressure imposed by the central bank’s

14 rate rises since December 2021, with BoE staff estimating that only about half of
the impact on gross domestic product has been felt to date. The BoE forecast also

suggests the UK government will hit its goal of halving inflation by the end of the

year but that inflation will only drop below the bank’s 2 per cent target at the end of

2025. It now expects inflation of 3.1 per cent in the final quarter of 2024, higher than

previously predicted, before inflation drops to 1.9 per cent in the final quarter of the

following year. Chancellor Jeremy Hunt said after the BoE’s forecasts were published

that the UK economy had been “far more resilient than many expected”. But the

BoE’s gloomy growth predictions contrast with a more upbeat assessment in the US,

where Federal Reserve chair Jay Powell this week highlighted the resilience of the

country’s economy. Thursday’s MPC vote came after similar decisions to keep rates

on hold by the Fed on Wednesday and the European Central Bank last week. Those

stances have bolstered investors’ confidence that the global rate-rise cycle may have

reached its peak. Swaps markets are pricing in the first BoE cut for August or

September next year. London’s benchmark FTSE 100 and the mid-cap FTSE 250

closed up 1.4 per cent and 3.4 per cent, respectively, with interest rate-sensitive real

estate groups among the biggest winners.

 Commentary number 2

Macroeconomics
Introduction

The Financial Times' article, "United Kingdom’s Long-Run Prosperity Hinges on Ambitious

Reforms," authored by the IMF European Department, critically examines the UK's current

economic situation and its strategies for improvement. It discusses the challenges posed by

global events, like Russia's war in Ukraine, which have led to high inflation which is the rate

at which the general level of prices for goods and services is rising, diminishing purchasing

power and underscores the struggle to control high inflation. The article emphasizes the Bank

of England's (BoE) contractionary monetary policy, and its approach, including raising

interest rates which is the cost of borrowing money or the return for investing it. In the

article, the Bank of England's decision to maintain interest rates at a 15-year high is a central

focus, impacting inflation and economic growth which is defined as an increase in the

amount of goods and services produced per head of the population over a certain period.
The diagram above is an (AD-AS) Keynesian model. This model helps to illustrate the total

spending (aggregate demand or AD) on the nation's goods and services and the total

production (aggregate supply) at different price levels. In the diagram, AD1 represents the

initial aggregate demand in the economy. The vertical line, LRAS, represents the Long-Run

Aggregate Supply, indicating the maximum possible output of the economy at full

employment without causing inflation. The SRAS line represents the Short-Run Aggregate

Supply, which can vary with the level of demand. When interest rates increases, borrowing

becomes more expensive. This discourages spending and investment, which decreases the

aggregate demand from AD1 to AD2. The shift of AD to the left reflects this fall in

demand.
The price level falls from P1 to P2. This represents the average prices of goods and services in

the economy coming down as there's less demand.

Real output decreases from Y1 to Y2. This represents a reduction in the total production or

GDP because businesses are selling less and may cut back on production.

The article reflects this theory by discussing how the Bank of England is using monetary

policy specifically interest rate hikes to reduce inflation. By increasing interest rates, they aim

to lower spending and borrowing, which in turn should reduce the aggregate demand. This

reduction in demand is supposed to decrease the price level (helping to control inflation) and

can also affect real output or GDP growth (potentially slowing the economy).

Evaluation:

The policy aims to temper demand-pull inflation by making borrowing more costly.

The benefit of this policy is that higher interest, which can lead to a series of beneficial

outcomes. For example, the cost of servicing debt increases. This situation discourages both

households and corporations from taking on new debt and can motivate them to pay off

existing debts, leading to lower levels of overall indebtedness. With higher interest rates, only

the most creditworthy borrowers will be able to afford loans, leading to more prudent lending

practices by banks. This can result in a healthier financial system with more sustainable

borrowing. Higher interest rates can also provide greater returns on savings, encouraging

individuals and businesses to save more. The article quotes BoE Governor Andrew Bailey,

emphasizing the cautious approach in considering further rate hikes: "It’s much too early to be

thinking about rate cuts." The decision to hold rates at 5.25 percent for the second successive

meeting highlights the BoE's commitment to a tight monetary policy stance. If higher interest

rates lead to decreased demand for borrowing, this can reduce the competition for purchasing

houses. Lower demand may halt the rapid increase in housing prices, potentially making
housing more affordable over time. Higher interest rates can draw foreign investment and

boost the currency, potentially lowering the current account deficit. However, they may also

dampen economic growth as elevated borrowing costs discourage spending, leading to

reduced output and higher unemployment a scenario depicted by the short-term Phillips

Curve, where efforts to curb inflation could elevate joblessness.

The long-term implications of the BoE's policy are further complicated by the Phillips

Curve's progression over time.

 The Phillips Curve suggests a short-term trade-off between inflation and

unemployment, but in the long run, this relationship may not hold, potentially leading to

stagflation a mix of high inflation and unemployment challenging the BoE's policy-making.

The BoE's projection of near-term flat growth and risk of recession in 2024 signals its concern

about preserving economic stability amid such trade-offs.

Governor Andrew Bailey's cautious approach reflects the BoE's careful navigation of

monetary policy against a backdrop of global economic uncertainty a contrast to the more

optimistic outlook in the U.S. The BoE's strategy, aimed at tempering demand-pull inflation

by tightening borrowing costs, seeks to align demand with supply to stabilize prices, with an

eye on wider economic repercussions, including impacts on the housing market and foreign

investment.

Acknowledging cost-push factors like energy price shocks, the article notes the BoE's

limited influence over such inflation drivers. Although the central bank's measures may

initially curb inflation, the Keynesian model reveals potential for long-term economic

slowdown, highlighting the delicate balance between immediate inflation control and

sustained economic growth.

Bibliography

Blink, J. (no date) Oxford IB Diploma Programme: IB Economics course book, Google Books.
Available at: https:/books.google.com/books/about/Oxford IB Diploma Programme IB
Economics.html?id=cQdUzQEACAAJ
(Accessed: 25 December 2023).

Phillips curve (2023) Corporate Finance Institute. Available at:

https://corporatefinanceinstitute.com/resources/economics/about-phillips-curve/ (Accessed: 20
December 2023).

The phillips curve (macro review) - macro topic 5.2 (2014) YouTube. Available at:
https://www.youtube.com/watch?v=zatnIhwmulc (Accessed: 25 December 2023).

YI 5) causes of economic growth (short run and long run) (2020) YouTube. Available at:
https://www.youtube.com/watch?v=5vDHdxitSTU (Accessed: 18 December 2023).

Article : Bank of England warns UK faces stagnating economy as it keeps rates at 5.25%. Available
at: https://www.ft.com/content/a651ddal-890-448b-b624-e8d41592020e (Accessed: 16 December
2023).