While the furlough scheme ended shutdowns triggering soaring unemployment, the current lack of a wage subsidy means the labor market now faces a tougher challenge with the cost of living crisis.
Vacancies are at an all-time high and the unemployment rate has fallen to 3.8% since the lockdowns ended. A high number of vacancies relative to job seekers means unemployment is expected to fall further to 3.6% in the coming months, although the Bank believes the boiling job market will cool by then.
Bank of America economist Robert Wood said the bank should “keep rising until unemployment rises,” which he predicts will happen around September.
The Bank expects unemployment to cross the 5% mark in 2024 and exceed the peak of the pandemic the following year. Rising unemployment to 5.5% suggests more than 500,000 Britons will lose their jobs over the next three years in the biggest wave of layoffs since the financial crisis.
Ben Broadbent, Deputy Governor of the Bank of England, said: “The big moving parts here are not politics.
“The big moving parts of this forecast are the extreme jump in these import prices this year and then leveling off. This is the story of the forecast.
The forecast will mount pressure on the chancellor – both politically and fiscally: a sharp drop in living standards will increase pressure on Sunak to present more support, but stagflationary forces will also weaken his hand by hurting finances public.
While higher inflation may help bolster UK coffers by boosting tax revenue in cash terms, the growth downgrades mean Sunak could see his pre-election war chest reduced.
Philip Shaw, chief economist at Investec, says inflation is a “double-edged sword” for Sunak, but adds that the weaker growth forecast “undoubtedly leads to a worse fiscal outcome”.
“There would be more pressure on public finances if the economy stagnates, which is effectively what the Bank of England forecasts say,” Shaw said.
Every percentage point removed from growth means the country’s deficit increases by 0.7 points over two years, according to Oxford Economics.
In March, forecasts from the Office for Budget Responsibility suggested Sunak had £30billion available for freebies ahead of an election if the chancellor stuck to his budget rules.
However, this fiscal leeway could disappear if growth is disappointing or if the economy backs down. According to Capital Economics, the Bank’s forecast implies that the Chancellor’s war chest will be wiped out by a weaker-than-expected economy.
James Smith, research director at the Resolution Foundation, said the “awful” outlook for living standards “could make monetary policy decisions more difficult, but it would make fiscal policy decisions much easier”.
He says: “Government cannot shield us all from the pain of rising energy costs, but can and should provide more targeted support to low and middle income households most affected.
While the Bank of England’s monetary policy has supported the economy in previous downturns, it will be a headwind this time around as it squeezes households and businesses with rate hikes.
The Bank of England has sought to dampen expectations of a sharp rise in borrowing costs, but markets are still bracing for five more interest rate hikes over the next 12 months.
Raising the Bank’s base rate from its current level of 1% to over 2%, as investors expect, will hurt households due to soaring mortgage costs and dampen growth by reducing demand . Hiking too aggressively and too far could tip the economy into recession.
Sanjay Raja, Economist at Deutsche Bank, said: “Governor Bailey made it clear in his opening remarks that the MPC is now taking a ‘narrow’ path to tackling inflation while avoiding an outright recession.
He says “the path for further hikes is narrowing” and expects two more rate hikes this year to follow the four consecutive rate hikes already.
The MPC appears split on how aggressively to stamp out inflation with three rate regulators voting to raise rates by 50 basis points to 1.25pc. However, two politicians have suggested that no further policy tightening will be needed.
James Smith, an economist at ING, says the Bank said in its report that it thinks “investors are expecting too much tightening over the next year”.
“Expect more upside, but not as much as markets expect,” he says. “The new guidance, combined with the growing division among committee members, suggests the Bank is approaching a pause in its tightening cycle.”
Bailey, meanwhile, explicitly tried to dissuade the markets from their lofty interest rate expectations, saying: “There are people who think we should raise interest rates a lot more than that and we don’t agree with that.”
Fewer rate hikes could lessen the pain caused by rising mortgage and borrowing costs. But the direction of travel for the UK will be much the same: 40-year high inflation, severe income compression and an economy on the brink of recession.