The Russian war in Ukraine is beginning to impact the UK. According to the governor of the Bank of England (BoE), Andrew Bailey, the conflict leads “a historic shock to real incomes”. During a conference of the Bruegel institute on Monday March 28, the latter pointed out that the rise in energy prices had reached a level which had never been observed during the 1970s, which were nevertheless marked by a shock oil tanker that had caused inflation for several years.
“We expect growth and demand to slow, and we’re starting to see that in our business and consumer studies,” said the governor of the BoE.
Less well-off households, those who were unable to save money during the pandemic and who spend more of their income on heating and transport, will be the first to be affected, underlined Andrew Bailey.
This sad forecast comes after a very dynamic 2021 for the United Kingdom, which last year recorded record GDP growth of 7.5%, after a contraction of 9.4% seen in 2020. Even before the start of the war in Ukraine, the BoE and economists were anticipating growth of around 3.75%. Some were even already warning that inflation and rising taxes would constrain growth.
Tightening monetary policy to deal with inflation
For all central banks, the war in Ukraine represents a new dilemma: the disruption of the market for energy and other raw materials (wheat, aluminium, etc.) is driving up prices, aggravating inflation that was already high before the conflict . In the United Kingdom, inflation reached 5.5% in January and even 6.2% in February, levels well above the 2% initially hoped for by the BoE. It should also increase further according to the forecasts of the monetary institute.
To try to counter this galloping inflation, central bankers must choose between maintaining ultra-accommodative monetary policies, at the risk of seeing inflation set in for a long time, or raising their rates, which weighs on borrowing capacity and on personal and corporate loans.
The BoE has chosen to raise its rates three times since the end of 2021. The last time was on March 17 with an interest rate hike of 0.25 percentage points, to 0.75%. She justified her decision by “tightness in the labor market, continued signs of inflationary costs and pressures, and the risk that they will persist”.
The BoE has also warned that it is « probable » that the war in Ukraine “exacerbates supply chain disruptions”. “Inflationary pressures will therefore strengthen considerably in the coming months, while growth in net energy-importing countries such as the United Kingdom is expected to slow,” warns the BoE.
The BoE has recognized that if a “modest additional monetary policy tightening would likely be needed in the coming months”, “risks exist on both sides of this judgment”. The head of the BoE assumed this Monday, March 28 to reflect the uncertainty hanging over the market, and ensures that he has not taken a decision on a possible fourth rate hike in May. “All I know for sure is that there will be a meeting in May,” he joked.
Peak expected in October
“Inflation will rise further in the coming months, to around 8% in the second quarter of 2022, and possibly even higher later in the year,” warns the BoE. It had forecast that inflation would peak in April at 7.25% due to the rise in gas and oil prices, which will push the British energy market regulator to increase the regulated price of electricity. But the conflict in Ukraine having caused the cost of hydrocarbons to soar, the cap on electricity prices could increase further in the United Kingdom when it is next revised in October.
The BoE no longer rules out inflation at the end of this year “several percentage points above what was expected”. And “over the longer term, inflation is expected to slow markedly,” notes the BoE, it is under a grim scenario: the cost of electricity on the purchasing power should destroy part of the demand.
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ZOOM: LONDON READY TO WITHDRAW ITS SANCTIONS IN RUSSIA UNDER CERTAIN CONDITIONS
While the UK has imposed sanctions on more than 1,000 Russian or Belarusian individuals and companies in recent weeks, these could be lifted if the Kremlin commits to a full ceasefire, withdraws its troops from Ukraine and pledged not to commit further aggression against Ukraine, British Foreign Secretary Liz Truss said in an interview with the Sunday Telegraph on Saturday (26 March).
These statements echo those of US Secretary of State Antony Blinken indicating that the sanctions against Russia “were not intended to be permanent” and that they could disappear if Moscow changed its attitude.
The British minister also indicated that she had set up a unit specializing in negotiations within her ministry to assist Ukraine in its talks with Russia. She cautioned, however, that she could only be useful once the “Russians will be serious” in their willingness to negotiate. “I don’t think they are serious now and that’s why I said you have to be tough to get peace,” she added. It is therefore necessary to “double the penalties” and “double the weapons we send to Ukraine”, she assured.