BoE offers bleak forecasts as Brexit 'fog' deepens further

The Bank of England expects UK growth to slow much more in 2019 than was previously forecast, and sees a risk of recession even in the event of a relatively “soft” Brexit.

Today (February 7), the BoE released a central projection for 2019 GDP growth of 1.2%, a sharp downward revision relative to the 1.7% forecast it put out in November.

The forecast is based on what BoE economists judge to be the average of all possible Brexit scenarios. At the press conference today, governor Mark Carney conceded the risk of a costly “no-deal, no-transition” Brexit had risen.

“This is a time of quite considerable uncertainty about one of the most important issues facing this country,” Carney said. He added it was now looking unlikely that all issues related to Brexit would be “tied up in a nice package” by the end of March, when the UK is currently due to leave the European Union.

UK Prime Minister Theresa May has promised to return to Brussels to renegotiate the Irish “backstop”, a key point of contention among Brexit-backing lawmakers. But EU politicians have indicated they will not budge on the issue.

The backstop would keep the UK in a customs union if no other option is found before the Brexit transition ends, thereby avoiding a hard border in Ireland.

However, in the event of a “no-deal” Brexit, there would be no transition and no clarity on the UK’s future trading relationship, or the status of the Irish border.

The heightened uncertainty has led to a sharp drop in investment. Though the economy continues to grow, “actual business investment” is likely to have fallen about 3% over the last year, according to the latest indicators, Carney said. The drop in investment since the Brexit vote in June 2016 had been “remarkable”, the governor said, leaving the UK “an absolute outlier” relative to its peers.

According to the BoE’s regional network, around half of businesses say they are not adequately prepared for a no-deal Brexit. Carney said many of those that say they are prepared have “done all they can”, but some problems posed by a disorderly Brexit are not ones businesses can “self-solve”.

Rates on hold

Amid the uncertainty, the BoE’s monetary policy committee chose to keep the policy rate on hold at 0.75%. It also kept the combined size of the two main asset purchase programmes at £445 billion ($577 billion).

UK growth slowed towards the end of 2019, from 0.6% quarter-on-quarter in Q3 to 0.3% in the Office for National Statistics’ latest three-month rolling estimate, for September to November. The BoE expects a further decline in early 2019.

Similarly, the headline consumer price index fell to 2.1% in December. The central bank expects this to fall below the 2% target “in the near term”, before rebounding slightly.

The outlook depends heavily on the result of Brexit negotiations. Carney stressed today that a political breakthrough that achieved clarity on Brexit, could unleash investment and boost growth in the latter stages of the year.

If a breakthrough comes more quickly than anticipated, growth could rise by around 0.5 percentage points on average over the forecast horizon, which extends to 2021, and 0.4 percentage points in the longer term, Carney said. But if uncertainty were to rise further and financial conditions tighten more, demand could fall and leave inflation below target.

Flexible response to “hard Brexit”

The BoE has said it will not respond automatically to a disruptive Brexit, and could even tighten rates under certain circumstances. Decisions will be based on the balance of supply, demand and the exchange rate – all of which are likely to fall in a no-deal scenario, but by uncertain amounts.

Judging that balance may be difficult due to lags in data. Carney said the BoE would draw on survey data in the short term, though such data needs to be used with care – he noted surveys overreacted to the 2016 vote. On the supply side, some information, such as labour market data, would be more timely, he added.

Deputy governor Ben Broadbent said the BoE had been coping with uncertainty over issues such as productivity for many years. “We’re not unused to having to infer what is happening to underlying supply,” he said.