Stock - Bank of England / BoE
The BOE’s forecasts will take center stage on Thursday as both investors and economists widely expect the MPC to keep the key rate at 5.25 per cent for a second consecutive meeting. Image Credit: Bloomberg

The Bank of England this week is likely to forecast a bleak period for the UK economy in the months leading up to the next general election, adding to worries for Prime Minister Rishi Sunak’s government.

The central bank’s Monetary Policy Committee (MPC) is set to revise down its estimates for gross domestic product in the second half of this year and early 2024 after surveys and official data pointed to an increased risk of a recession.

A downgrade from the relatively stagnant pace of growth the BOE expected in August would increases the chances of a recession in the coming months. That would be problematic for Sunak, who must call an election before the end of January 2024.

The Conservative Party is currently trailing Labour in polls and has suffered resounding defeats in recent by-elections. Efforts by Sunak to cut government expenditure and ease burdens on business “- such as by rowing back on net zero pledges and axing part of Britain’s HS2 rail network “- have done little to boost his popularity or stir growth.

“GDP growth has been weaker, the unemployment rate is higher and pay growth is finally easing across all gauges. Financial markets have responded to the recent flow of news by pricing in a smaller-than-50 per cent chance that interest rates reach 5.5 per cent, having seen a peak expectation of over 6 per cent in the summer,” according to Bloomberg Economists Dan Hanson and Ana Andrade.

Bleak employment outlook

The BOE’s forecasts, rather than the Bank’s interest rate decision, will take center stage on Thursday, as both investors and economists widely expect the MPC to keep the key rate at 5.25 per cent for a second consecutive meeting. The outlook also is likely to point toward an increase in unemployment to around 5 per cent in the coming months, up from a 50-year low of 3.5 per cent reached last year.

BOE Governor Andrew Bailey, after pushing up interest rates to the highest since 2008, has signaled that borrowing costs won’t be able to fall until inflation is well under control. Britain has the worst inflation problem in the Group of Seven, with prices rising at more than triple the 2 per cent target.

Money markets have recently pared bets on further monetary-policy tightening following signals from the the European Central Bank and US Federal Reserve that rate hikes may have already peaked. That’s lowered the chance of a final BOE quarter-point hike by early next year to around 40 per cent based on swaps tied to policy-meeting dates, while two cuts of 25 basis points each are expected by the end of 2024.

“We see limited likelihood of further hikes being required,” wrote Moyeen Islam, a rates strategist at Barclays Plc, saying the monetary policy report will likely signal policy makers are content with the current level of rates.

This is bearing down on growth. In the minutes of its last meeting in September, the MPC said it expected “GDP to rise by only 0.1 per cent in 2023 Q3, compared with the 0.4 per cent increase incorporated in the August Report.” On top of that, “underlying growth was also likely to be weaker than the 0.25 per cent per quarter built into the August projection for the second half of 2023,” it said.Most economists expect a cut in the GDP forecast next year from 0.5 per cent, and many expect the BOE to lower this year too.

“For GDP, the near-term profile should be revised down based on recent monthly outturns, and we see the Bank retaining its weak outlook,” said George Buckley, chief UK and euro area economist at Nomura. “As for unemployment, we think there are upside risks to the Bank’s profile.”

Beyond next year, economists think the picture could get a little rosier. Simon French, chief economist at Panmure Gordon, noted recent positive revisions to 2020 and 2021’s GDP level, a reduced risk that inflation expectations were heading higher than reality, and a plateauing of interest rate expectations “- all of which have “improved the medium-term outlook.”

More immediately, however, Britain’s inflation rate was 6.7 per cent in September, and increasing numbers of economists are expecting a recession in the coming quarters.