Bank of England sets out three-point plan to fix UK economy with dire warning (2024)

Bank of England sets out three-point plan to fix UK economy as dire warning issued (Image: Getty)

A deputy governor of the Bank of England has said she is "more worried" about the risks that inflation will be higher than expected as she called for a "gradual" reduction in interest rates.

In a speech today, Clare Lombardelli shared an update on the Bank of England’s outlook for the economy, emphasising the challenges the UK faces in tackling "lasting inflation."

She noted that the Bank’s Monetary Policy Committee (MPC), which makes decisions on central interest rates, previously outlined three potential economic scenarios, each with different implications for inflation and the Base Rate.

In "Case 1", the unwind of external shocks could drive disinflation, gradually bringing inflation back to its 2% target as supply and demand pressures ease. This scenario assumes that the more persistent components of inflation, which were influenced by external factors, will eventually revert to normal levels.

If this scenario plays out, the Deputy Governor noted: "Monetary policy restriction will need to be reduced more quickly."

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Repercussions of the Chancellor's Autumn Budget could raise "concerns" for "lasting inflation". (Image: Getty)

As evidence of this trend, she pointed to the faster-than-expected progress in disinflation so far, with inflation forecasts for 2024 now lower than previously anticipated.

In Case 2, the unwind of external shocks would lead to slower disinflation, requiring continued restrictive monetary policy for inflation to return to target. This is the scenario the Bank is currently working with, expecting tight fiscal and monetary policies to help moderate wage and price growth.

However, the Deputy Governor expressed particular concern over Case 3, which describes “deeper structural changes” in the UK economy that could lead to a more lasting inflationary cycle.

She explained: "Deeper structural changes in the UK economy threaten to impart a more lasting inflationary dynamic, if not met with a longer-lasting restrictive monetary policy response."

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This scenario suggests that real income catch-up effects might lead to a situation where wage growth remains elevated, potentially around 3.5% to 4%, with inflation stabilising closer to 3% rather than the target of 2%.

If this dynamic takes hold, it could be much more challenging to reverse, and would require a more significant monetary policy response.

The Deputy Governor acknowledged that each of the three cases is consistent with current economic evidence, and the future course of the economy could align with any of them.

Yet, she emphasised that "the probabilities of downside and upside risks to inflation are broadly balanced".

Ms Lombardell continued: "But at this point I am more worried about the possible consequences if the upside materialised, as this could require a more costly monetary policy response. The outlook for wages and services prices is unclear from here.

"This is why I support a gradual removal of monetary policy restriction and will be monitoring the flow of data over the coming months so we can calibrate our policy path as needed."

The Bank of England reduced the Base Rate from 5% to 4.75% in November due to sustained lower-than-target inflation. However, experts warn repercussions of Chancellor Rachel Reeves’s Autumn Budget has “unleashed a number of potentially inflationary forces”, lwhich could lead to higher interest rates for longer.

Scott Douglas, capital markets director at international corporate finance firm Centrus, said: “Factors from the recent Autumn Budget such as National Insurance Contribution hikes, Trump’s election win and the potential rise in import costs stemming from tariffs coupled with the strengthening of the US Dollar could all have a significant impact. The prospect of further energy price rises will drive inflation upwards - despite falling wage growth figures.”

“As well as heightened inflation, markets are now expecting interest rates to remain higher for longer - meaning we could be staring down the barrel of an economic groundhog day.”

Rohit Kohli, Director at The Mortgage Stop said: “With the recent Budget's impact and escalating global tensions, it’s highly unlikely that the already cautious Bank of England will cut the base rate in December.

“Struggling households and businesses hoping for relief through lower rates will face ongoing pressure. This rise will likely dent business confidence even further, hindering growth at a crucial time for the economy."

The Bank of England’s MPC will meet again to decide on Base Rate changes on Thursday, December 19.