The UK is set to enter recession this year but it will be shorter and less severe than previously thought, according to the Bank of England.
The slump is now expected to last just over a year rather than almost two as energy bills fall and price rises slow.
As a result, fewer people are likely to lose their jobs, but the number of job vacancies – currently close to record levels – are expected to fall.
The fresh forecast came as the Bank raised interest rates to 4% from 3.5%.
It is the tenth increase in borrowing costs in a row and will add pressure to many households already struggling with the cost of living.
The impact will be felt by borrowers through higher mortgage and loan costs, although it should also mean better returns for savers.
Homeowners with a typical tracker mortgage will now pay about £49 more a month. Those on standard variable rate mortgages face a £31 increase.
The Bank has been putting up interest rates to tackle inflation, which at 10.5% remains close to its highest level for 40 years – more than five times what it should be.
Higher interest rates are meant to encourage people to save more and spend less, helping to stop prices rising as quickly.
The Bank had previously said that it would act “forcefully” to control rising prices, but on Thursday softened its stance saying it only raise rates further if it saw further signs inflation would remain high.
The Bank had previously said it expected the UK to fall into recession at the end of last year, with the downturn lasting until the middle of next year. It now expects the slump to be shorter – starting in the first three months of this year and lasting until the end of March next year.
A recession is defined as when the economy shrinks for two consecutive three-month periods. Typically companies make less money and cut jobs, leaving the government with less tax revenue to spend on public services.
The Bank is now predicting:
- The economy will shrink by 1% versus 3%, largely because “wholesale energy prices have fallen significantly.”
- Unemployment will peak at 5.3% rather than 6.4%. It is currently 3.7%.
- Inflation will fall back to 8% in June before dropping further to 3% by the end of the year.
- If workers get big pay rises it warns it could lead to a slower fall in inflation.
Chancellor Jeremy Hunt said the government would act in “lockstep” with the Bank to try to halve inflation this year.
That meant resisting the urge right “to fund additional spending or tax cuts through borrowing, which will only add fuel to the inflation fire”.
But Labour’s shadow chancellor Rachel Reeves said: “The reality is that under the Tories growth is on the floor, families are worse off and we are stuck in the global slow lane.”
Her comments come after a separate forecast from The International Monetary Fund suggested the UK would be the only major economy to shrink in 2023, performing worse than even Russia.