It is rare that a central bank governor surpasses even the most negative of economic forecasts. Yet, that is exactly what the usually reticent governor of the Bank of England (BoE), Andrew Bailey, did last week when he raised interest rates by half a percentage point and presented an astonishingly dire outlook for the UK economy.

Faced with soaring inflation, the rate increase was not a surprise. Rather, it was Bailey’s comments on the economy that caught markets offside. His outlook for the UK is apocalyptically grim and far worse than either the US or the Eurozone.

Bailey announced that the BoE is now expecting five consecutive quarters of recession, practically to the end of 2023, with GDP shrinking by at least 2% from peak to trough. This is likely to match the bleak years of the early 1990s and result in the sharpest drop in household incomes for 60 years. In a sobering statement, he stated that a painful squeeze on living standards was now “inevitable”, and necessary to bring inflation down. Even once a recovery began, the BoE said, growth would be “very weak by historical standards”.

To make things worse, they see inflation peaking at around 13% by the end of the year. Such a figure would have been unthinkable only a few months ago.

Almost more concerning is the complete absence of a sense of leadership or political responsibility. Prime Minister Boris Johnson has been conspicuous by his absence in recent weeks, despite the worsening economic crisis. Contemporary historian Sir Anthony Seldon called the end of the Johnson administration “lackadaisical”, with 10 Downing Street being a “hive of inactivity”. Last week, in the midst of this crisis and the worst heat wave in 80 years, he went on holiday to an undisclosed location. 

The current front-runner for the next PM, Liz Truss, has blamed the BoE for the dire state of the economy and spiralling inflation, promising to relook at its parliamentary mandate. This could have vital consequences for the future of UK monetary stability. 

At least investors can take solace from the brutal honesty with which the BoE is treating the situation. There has been no effort to sugar-coat the dire state of affairs. After the monetary and fiscal largesse of the Covid-19 pandemic, combined with supply-side cost shocks, restoring monetary stability comes with real economic consequences and trade-offs. 

“There is an economic cost to the war. But it will not deflect us from setting monetary policy to bring inflation back to the 2% target,” Bailey said. 

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Such a sentiment could have been uttered by South Africa’s own ultra-hawk, SA Reserve Bank (Sarb) Governor Lesetja Kganyago. Only last month, he announced the biggest increase in borrowing costs in 20 years in a similar attempt to arrest surging inflation. Like its emerging market peers, the Reserve Bank is trying to increase borrowing costs ahead of developed market economies such as the US or the UK. 

Where Sarb is far more guarded than the BoE is on the damage it is likely to wreak on the South African economy. The South African economy is forecast by the Reserve Bank to grow by 2% in 2022, and consensus forecasts are that it will expand by 1.7% in 2023, and another 1.7% in 2024, largely on the back of global demand for commodities. 

If the BoE is correct and the UK, a bellwether of the global economy, is about to endure a crunching five consecutive quarters of recession, then it makes these forecasts predicated on rebounding global growth look absurdly optimistic. Even as Sarb battles higher food and fuel prices, the economy is essentially stagnant as it buckles under the country’s worst ever rolling blackouts. A global downturn will pull a midsized emerging market like South Africa down with it.

Interest rate increases of this magnitude are not a subtle instrument of paring inflation by tapping the brakes of the economy. They are more akin to wrenching up the handbrake in a blind attempt to avert a crash. Further interest rate hikes in South Africa will have a profoundly negative impact on growth and unemployment. 

The trade-off is clear: in an inflationary environment, regaining price stability comes with real short-term economic consequences. Furthermore, after a decade of stagnation, the economy could barely be more ill-prepared. South Africans should be prepared for tougher economic climes ahead. DM/BM