The economic outlook for the U.K. has "deteriorated materially" amid a rapid rise in inflation, the Bank of England warned as it increased the rainy-day buffer that banks must meet.
The Russia-Ukraine war spurred a spike in inflationary pressures and exacerbated the impact of the COVID-19 pandemic, the central bank said in its latest financial stability report. "Market interest rates and corporate bond spreads have risen sharply, reflecting expectations of further policy tightening," according to the July 5 report.
Inflation rose to a new 40-year high of 9.1% in May, from 9% in April, according to the Office for National Statistics.
In mid-June, the BoE hiked its key bank rate for the fifth time in a row, to 1.25%. Current market expectations point to a further increase of more than 150 basis points by the end of 2022, according to the report.
Amid rising inflation, major banks in the U.K. continue to have strong capital and liquidity positions and hold enough capacity to support lending even with the deterioration in the outlook, the central bank said. Even in severe economic outcomes, banks can still manage.
The BoE raised banks' countercyclical buffer, known as the rainy day fund, back to its pre-pandemic level of 2%. Banks have 12 months to meet the buffer, which sets the amount of extra capital that banks should hold to ensure resilience against a downturn, before it comes into force July 5, 2023.
The buffer was cut to zero in March 2020 at the onset of the pandemic so banks could have more funds to provide credit to the economy. "[Domestic] vulnerabilities that can amplify economic shocks remain broadly at their pre-pandemic level," the central bank said in the report.
The BoE published its report just hours before Chancellor Rishi Sunak resigned from Prime Minister Boris Johnson's government. "[The] public rightly expect government to be conducted properly, competently and seriously. ... I believe these standards are worth fighting for and that is why I am resigning," Sunak said in his resignation letter.