BoE policy-makers face fallout from political chaos

Bank of England (BoE) officials are facing the prospect of dealing simultaneously with a no-deal Brexit and political upheaval, after the government took the highly unusual decision to suspend parliament.

Prime minister Boris Johnson announced on August 28 that he would “prorogue” parliament from September 9 until October 14, after his request to do so was approved by the Queen. Parliamentary business will be suspended completely during that period unless lawmakers act to overrule the measure.

UK lawmakers opposed to a no-deal Brexit, which would mean leaving the European Union without a deal, now have a highly limited window in which to act. Their options include passing legislation to prevent a no-deal Brexit or bringing a motion of no confidence in the government. The UK must leave the EU by October 31, unless it requests a further extension.

The UK economy is already slowing, which the BoE attributes in large part to uncertainty from the ongoing political turmoil. Business investment has been particularly subdued, and GDP contracted 0.2% in the second quarter as firms ran down the inventories they had built ahead of the previous Brexit deadline in March.

Many outcomes are possible in the next two months, including the UK government agreeing a deal on Brexit with the EU or asking for an extension of the deadline. But politicians are getting ready to fight a general election, which could fall either side of the October 31 deadline, and may take place with the UK either in or out of the EU.

One date the government is reportedly considering for general election polling day is November 7 – the same day as the BoE is due to publish its monetary policy decision and updated forecasts.

Dates for monetary policy committee (MPC) meetings are fixed well in advance and the BoE is not expected to alter the timetable, even if the announcement coincides with polling day. According to the standard schedule, the first day of MPC deliberation would fall on the day of Brexit, October 31, with the second meeting on November 4 and the final policy vote on November 6.

Currently, the BoE is conditioning its forecasts on the UK striking a deal, which remains official government policy, even though the prime minister has said he is willing to leave without a deal if necessary.

Governor Mark Carney told Central Banking in a recent interview that the government’s stance was “very logical” as a negotiating position and did not mean a no-deal Brexit was the most likely outcome.

According to the BoE’s August forecasts, officials expect annual growth of 1% in the third quarter, rising to 1.4% in 2020. The MPC continues to expect that gradual interest rate hikes will be necessary, in contrast to the market, which expects a cut.

New analysis

On August 27, the BoE published analysis of how the shock of the 2016 Brexit referendum had affected the structure of the economy. The research was co-authored by MPC members Ben Broadbent and Silvana Tenreyro, with economists Federico Di Pace, Thomas Drechsel and Richard Harrison.

The authors view the referendum result as causing market participants to believe there will be a forthcoming negative shock to productivity in the tradable sector. According to their simulations, this accounts for the sharp drop in the value of sterling in the wake of the referendum result, even though the impact on growth has played out over a much longer horizon than many economists originally expected.

The authors’ simulation, using a two-sector small open-economy model, indicates the non-tradable sector will become relatively more productive over time as productivity falls in the tradable sector. The model also shows a “material” fall in investment, but resilient employment, consistent with how the economy has actually developed.

The model implies the tradable sector is currently enjoying a “sweet spot” as the full negative impact on productivity will not be realised until the UK actually leaves the EU, but exporters are benefiting from the weak pound. As such, the UK economy is likely to go through further adjustment after Brexit takes place, the authors warn.