Interest rate hikes are doing little to control inflation – But they will cause a recession.

Official figures on inflation for July are going to be published tomorrow. Bank of England's (BOE) forecasts (often incorrect) that inflation should come down to 6.8% from 7.9% in June. Inflation will, though, for the first time, fall below 7% when the figures are published tomorrow, but it has nothing to do with the interest rate rises. The inflation figures in June surprised most economists, mainly due to the fall in fuel prices leading to a substantial fall in inflation. And inflation will fall in July due to Ofgem's energy price cap falling by 17%.

Some may argue that Ofgem's energy price cap should have come down sooner than July, as the wholesale price of gas has been falling for some time now, but that is a separate debate. Both factors that will lead to inflation falling in June and July have nothing to do with interest rate rises, which begs the question of why the BOE has been raising interest rates over the last year. The current situation has had a dual effect of severely impacting household finances, which were already under strain, and causing chaos in the rental market. Furthermore, the Bank acknowledges that the full magnitude of the problem has yet to surface as households’ transition away from cheaper fixed-rate mortgages.

The BOE says wage growth is too high:

Today's latest figures show that wages, including bonuses, were up by 8.2%, much higher than the economists forecast of 7.4%. This is the fastest pace of growth since monthly statistics were first measured in 2008. One-off NHS bonuses played a large part in the wage growth data in June.

This data will for sure certainly encourage the BOE to raise interest rates further at its next meeting in September as Governor Andrew Bailey and the Chief Economist at the BOE, Huw Pill, said wages were rising too fast to bring inflation under control and asked people to accept the fact that they were poorer. And what does the BOE do to set an example and show people how to accept being poor? They pay themselves £25 million in bonuses. The Governor of BOE, who led calls for pay restraints for fear of a wage spiral making inflation more stubborn, was paid £500,000 a year after bonuses. Anyway, I digress, but policymakers need to reflect on whether they deserve this after successive policy failures from the Bank.

The real issue is that wages are not growing at a record rate; the data might suggest that, but when you look further into the data and account for inflation, the wages have fallen since 2008. Take a step back, and wages are about £1,000 lower than in 2008. The British worker is poorer today than they were over a decade ago. And regular pay is still rising slower than inflation at 7.8% Vs 7.9%.

The unemployment rate is rising:

There are signs that the latest interest rate rises are keeping people out of work longer as firms become more cautious in hiring and unemployment rose to 4.2%. That defied economists' expectations, who expected the unemployment rate to remain 4%. Job vacancies have fallen over a quarter of a million since last year. However, they do remain significantly above the pre-pandemic levels.

Recession warning lights are flashing: 

The recession warning lights are flashing so bright that slamming the brakes on is the most sensible course of action. The BOE has already raised interest rates at the fastest pace in more than 30 years—the impact of which is becoming clear. UK factory output is falling at its fastest pace in seven months, and the housing market is in its worse slump in nearly a decade and a half. The unemployment rate has started to tick up, and growth is negligible. The economy will take a lot of work to stomach further interest rate hikes. 

The monetary policy committee has always been behind the curve, and the fear is that they will do the same again, leading to a more prolonged and painful recession. Inflation is falling, the product input index, which tracks the costs of raw materials and components used for manufacturing, turned negative in June, and energy prices are falling too. The impact of interest rate rises will take a year to feed through the economy.

In any case, we are close to the inflation summit, and the hope is that the Bank realises that and does not put up interest rates beyond 5.5%. The longer the interest rates remain high, the higher the risk of a prolonged recession.