Bank warns of longest recession in 100 years as it raises rates to 3%

The Bank of England has warned the UK risked being plunged into the longest recession in 100 years after it pushed up the cost of borrowing to 3% in the biggest single interest rate rise since 1989.

A 0.75% increase, the latest in a series of eight interest rate rises since last year, would not be enough to guarantee victory in the war against double-digit inflation, the Bank said, as it cautioned further action would be needed.

With the possibility of a general election being held in 2024, the Conservatives face campaigning to remain in government at the tail end of a prolonged slump, during which the Bank said it expected unemployment to rise from 3.5% to 6.5%.

However, there was some relief for mortgage holders as the central bank downplayed City expectations of a steep rise in the cost of borrowing to above 5%, arguing that the prospect of a two-year recession meant it was likely to take a much less aggressive stance.

Bailey and his officials expect inflation to fall to zero by 2025, and analysts at Berenberg Bank are forecasting only one more rate rise, to 3.5%.

Bailey said higher borrowing costs were already affecting households.

Homebuyers with tracker or variable rate mortgages will feel the pain of the rate rise immediately, while the estimated 300,000 people who must remortgage this month will find that two-year and five-year fixed rates remain at levels not seen since the 2008 financial crisis.

It blamed higher energy prices and a tight labour market for the big increase, which matched aggressive rises in the last week by the US Federal Reserve and the European Central Bank.

The vote to raise rates was split 7-2 among the nine members of the monetary policy committee (MPC) after Silvana Tenreyro voted for a 0.25% increase and Swati Dhingra voted for a 0.5% jump. Both are professors at the London School of Economics. They argued the full effects of eight consecutive rises should be allowed to feed through into the wider economy before more severe action was taken.

On alternative assumptions that rates remained unchanged at 3%, the economy would still continue contracting until the end of 2023 but the cumulative fall in output would be 1.7% rather than 2.9%, and unemployment would peak at just over 5%.

The Bank said it had not factored in any action by Hunt in his autumn statement on 17 November, though the chancellor is expected to announce a package of tax increases and spending cuts worth up to £50bn.