In the months preceding the EU referendum, there were repeated warnings regarding the economic dangers that a vote to leave would pose. Ten of the world’s leading economists expressed their concerns and urged voters to vote to remain in the EU, asserting that Brexit would create major uncertainty about Britain’s alternative trading arrangements and that the negative impacts would persist for many years. HM Treasury published a report in April saying that a Leave vote would mean ‘Britain would be worse off by £4,300 per household per year’. Most notably, perhaps, the governor of the Bank of England (BoE), Mark Carney, said that Brexit could ‘knock the pound sharply lower, stoke inflation and raise unemployment’. However, despite strong warnings from the Bank and numerous economic and political figures around the world, the majority of UK voters chose to leave the European Union.
As a result of this decision, the economy and therefore the Bank of England now face many challenges, in particular, the pound’s depreciation and the fall in confidence of firms and consumers. The currency plunged to a 31-year low against the dollar, and while it has recovered to some extent, it is still weaker against most currencies around the world than it was before the referendum. As imports become more expensive, it is likely that this will lead to higher UK inflation, with some economists estimating that inflation could rise as high as 5% over the next two years.
The referendum result will leave behind a long-term undercurrent of uncertainty that is likely to trigger a slowdown in investment and consumer spending. Surveys and comments from retailers have already indicated a fall in consumer confidence since the vote, with a survey by market research firm GfK indicating that ‘consumer sentiment fell at the fastest pace in more than twenty years since the Brexit vote’. Firms and markets thrive off some element of certainty and resent periods of uncertainty, such as that which the referendum result was presented. According to the Financial Stability report, inflows of foreign investment will suffer as a result of a substantial period of uncertainty, making it more difficult to support the UK’s growing current account deficit. Investment is a key engine of economic growth, and the effect of a slowdown in investment in the UK could tip the economy into recession or at least cause a severe downturn. The MPC is faced with a fine balancing act between guarding against recession, which will hit households with higher unemployment, and preventing against rises in inflation, which will reduce real incomes for consumers.
Despite a rather gloomy economic outlook, Carney has done well to reassure markets over the past couple of weeks and while acknowledging that ‘challenging times lay ahead’, he has provided careful optimism and has displayed honesty and transparency in his outlook for the future. A positive outlook from the governor of the Bank of England will surely go a long way in influencing consumer and investor confidence. Carney concedes that though “the future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of the Bank of England”, the Bank can help to promote stability in order to influence and facilitate decisions made by firms and consumers which will ultimately determine the fate of the UK economy.
Intervention has already begun, with the Bank having recently taken steps to increase the lending capacity of commercial banks by £150bn through easing capital requirements. The Chancellor of the Exchequer, George Osborne, has recently signed a letter with eight major banks, including HSBC and Barclays, agreeing to make extra capital available for lending to firms and consumers. The Financial Policy Committee has stated that this will allow banks to increase credit supply to households and businesses. Additionally, Carney stated that ‘preparation ahead of the referendum was now paying off’ and that the BoE has a ‘clear plan’ and is ‘rapidly putting its main elements in place’. This will help to provide reassurance to market participants with regards to the future stability of the economy as the Bank appears in control.
by the BoE to date
Firms and consumers are eagerly anticipating the next meeting of the Monetary Policy Committee (MPC) on Thursday. Pre-referendum, the Bank had stated that a rate rise was likely at the end of this year. However, the direction of monetary policy has changed as a result of the referendum, with Carney hinting at a cut in the base rate as soon as this month. Many economists are expecting a rate cut to 0.25% while some even think a fall to zero is likely either this month or the next. Either way, financial markets are pricing in a 78% chance of a rate cut this Thursday, according to Ben Brettell, senior economist at Hargreaves Lansdown, indicating that market participants are anticipating a further loosening of the monetary policy very soon. However, Carney has maintained a strong position against cutting rates below zero as the ECB and Bank of Japan have done, as he believes it could ‘hurt the banking industry’. In addition to this, the BoE may also resume quantitative easing, which has been on hold since November 2012, and has provided £375bn of stimulus to date. Extension of the BoE’s Funding for Lending scheme is also expected shortly, following its implementation shortly after the 2008 financial crisis, which should further increase lending by banks and building societies to help prop up the real economy.
There is no doubt that the UK economy is facing difficult and uncertain times, but the BoE’s messages and actions so far will hopefully have provided some reassurance to market agents. It is up to Carney and his colleagues in the MPC to continue to make sound policy decisions, both this Thursday and in the future, to reduce post-Brexit uncertainty and to foster monetary and financial stability to navigate the economy through these unchartered waters.