The UK’s economic prospects were given a gloomy assessment by the Bank of England (BoE). The central bank announced its biggest interest rate hike in 27 years, as it forecast inflation would hit 13% in the fourth quarter of the year. It also claimed the UK would enter a lengthy recession starting around the same time. The BoE’s 50-basis-point increase took borrowing costs up to 1.75%. Inflation expectations have accelerated since the rate-setting Monetary Policy Committee (MPC) last met. In June, the central bank was forecasting peak inflation of “slightly above 11%”.

The BoE thinks inflation will “remain at very elevated levels” throughout much of 2023, before falling to its 2% target “two years ahead”. With a 65% increase in Ofgem’s energy-price cap looming in October, already-elevated UK inflation is guaranteed to be given a significant turbo-charge later this year. The Bank is also treading a determined but careful path with its asset-disposal programme. The market had hoped to hear news on plans to wind down its Asset Purchase Facility (APF), which now houses £863bn of gilts and corporate debt. The Bank confirmed it will start sales in September, with about £80bn of gilts sold over a twelve-month period. This is just above the midpoint of market expectations (£50bn to £100bn). Given the profile of maturing gilts over this period, this would imply a sales programme of around £10bn, a level which is unlikely to upset markets too much. The Bank’s Governor Andrew Bailey also denied that the MPC acted too late to tackle the UK’s inflationary threat. “No-one knew a year, two years ago, that there would be a war in Ukraine,” Mr Bailey said.
 
The dire warning from the BoE dominated a television debate between prospective Conservative Party leadership candidates Liz Truss and Rishi Sunak as they continue to vie for the keys to Number 10 Downing Street. Ms Truss claimed her tax cut plans could avert a looming recession, bur Mr Sunak, stepped up his criticisms of her £30bn plan for unfunded tax cuts. “The lights on the economy are flashing red, and the root cause is inflation,” he said. “I’m worried that Liz Truss’s plans will make the situation worse.” Mr Sunak said there will be no tax cuts until late next year if he is elected leader to get the finances of UK plc on a better footing. Nevertheless, the former Chancellor has responded to Ms Truss’s tax plans by promising the biggest income tax cut in 30 years, pledging to slash the basic rate from 20% to 16% within seven years if he emerges victorious.

British households were warned that annual energy bills could increase to an average of £3,615 this winter, after energy consultant Cornwall Insight increased its previous prediction by hundreds of pounds. Greggs warned that it was increasing the price of a range of its products following a jump in costs. The high-street baker said costs across the group were expected to rise by 9% this year.

There were also hawkish statements from key members of the US Federal Reserve. Minneapolis Fed President Neel Kashkari said it was extremely unlikely that the central bank will pivot to cutting interest rates in 2023 – futures markets are currently pricing in US rate cuts from the start of next year. “Some financial markets are indicating they expect us to cut interest rates next year," Mr Kashkari said. “I don't want to say it's impossible, but it seems like that's a very unlikely scenario right now given what I know about the underlying inflation dynamics.” St. Louis Fed President James Bullard also said the central bank will be steadfast in raising rates to bring inflation back down.

Fed Chair Jerome Powell recently said the central bank may consider another "unusually large" rate hike at the September meeting. San Francisco Fed President Mary Daly said she thought next month’s meeting would have a 50-basis-point increase in mind.

Nevertheless, the US economy has shown signs of strength amid aggressive monetary tightening and runaway inflation. The American services industry unexpectedly picked up in July, as new orders grew solidly – supporting views that the economy was not in recession despite output slumping in the first half. The Institute for Supply Management (ISM) survey also showed supply bottlenecks were easing, while a measure of prices paid by businesses dropped by the most since 2017, which was partly due to declining commodity prices. Shortages of labour, especially truck drivers, persisted.