Negative GDP casts doubt over Bank plan to curb inflation

HOPES that runaway inflation could be tamed by a sharp rise in interest rates have been dashed by a surprise slump in the economy that has brought forward the shadow of recession.

The Bank of England’s Monetary Policy Committee (MPC) meets on Thursday to vote on a potential adjustment to the cost of borrowing, just as its forecasts have been thrown into disarray by an unexpected 0.3pc fall in GDP in April.

City economists tore up their forecasts following the revelation from the Office for National Statistics, abandoning predictions of a 0.5 percentagepoint rise. They now anticipate a smaller increase in the base rate from 1pc to 1.25pc, as the Bank attempts to calm price rises without accelerating the slide into a recession that could prove fears of 1970s-style “stagflation” too optimistic.

Inflation hit 9pc in April, its highest since the early 1980s as energy prices jumped with a 54pc increase in the energy price cap. The Bank of England expects another 40pc rise in bills to take inflation above 10pc in October.

Financial markets took fright on the drop in GDP, sending the pound down more than 1pc against the dollar to leave sterling trading at less than $1.22, close to its lowest level since the early stages of the pandemic.

Paul Dales at Capital Economics warned “GDP will remain weak over the coming quarters and a recession can’t be ruled out”. He added: “This may tilt the Bank towards continuing to raise rates by 0.25 percentage points rather than by the 50 percentage points from 1pc to 1.5pc we are forecasting.”

Thomas Pugh, economist at RSM, said the Bank will be spooked by the prospect of causing, or worsening, a recession. “We expect the MPC to tread cautiously with a series of 0.25 percentage point rises taking interest rates to 2pc by the end of the year” he said.

But there is still pressure for Mr Bailey and his colleagues to raise rates to bring expectations about future prices into line.

Yael Selfin, chief economist at KPMG UK, said the fall in the pound, which threatens to push up imported inflation even further, will focus the Bank’s mind on raising interest rates despite the risks to growth.