LONDON: The Bank of England cut its growth forecasts on Thursday in the face of increased Brexit worries and a slowing global economy, but gave no indication it was considering lowering interest rates like other central banks.
A day after the US Federal Reserve reduced rates for the first time since the global financial crisis, the BoE said it still expected to raise borrowing costs gradually — though this now hinged on a global pickup as well as a “smooth” Brexit.
“Profound uncertainties over the future of the global trading system and the form that Brexit will take are weighing on UK economic performance,” Bank of England Governor Mark Carney said after the announcement.
“Until they are resolved, shifting perceptions of these factors will drive volatility in market interest rates, equity prices and currencies’ values.”
The BoE’s Monetary Policy Committee (MPC) voted 9-0 to keep rates unchanged at 0.75 per cent, as expected in a Reuters poll of economists, and said that even after a no-deal Brexit it would not automatically cut rates.
With new Prime Minister Boris Johnson committed to taking Britain out of the European Union on Oct. 31 — regardless of whether he can secure a transition deal — markets see increased risks of a disorderly, no-deal Brexit.
The BoE said this had led to “a marked depreciation of the sterling exchange rate” — which is near a three-year low against a basket of other major currencies — and that as of mid-July, business uncertainty about Brexit had become “more entrenched”.
“Underlying growth appears to have slowed since 2018 to a rate below potential, reflecting both the impact of intensifying Brexit-related uncertainties on business investment and weaker global growth on net trade,” the BoE said.
There was little immediate market reaction to the statement.
“All eyes will be on the MPC’s September meeting. If a disorderly exit from the EU is on the cards, the Bank must not shy away from lowering interest rates in advance to support businesses and households through the turbulence,” the Institute of Directors’ chief economist, Tej Parikh, said.
The BoE’s forecasts assume Britain avoids a Brexit shock, but still foresee growth of 1.3 per cent for 2019 and 2020, down from 1.5 per cent and 1.6 per cent respectively in its last forecasts in May.
That would leave British growth roughly in line with that of the Eurozone, which Britain used to regularly outperform before June 2016’s referendum decision to leave the EU.
The forecasts also showed a relatively high 30 per cent chance of negative year-on-year growth in the first three months of next year. A recession is typically defined in Europe as two consecutive quarters of negative quarter-on-quarter growth.
Before Thursday, some analysts had said the BoE might adjust its long-standing guidance that it would raise rates in a limited and gradual way, given the growing possibility of a no-deal Brexit, something investors now increasingly expect.
Carney said Britain avoiding a no-deal had become a “less dominant” scenario but the BoE’s guidance was still valuable for steering market expectations for monetary policy.
“And quite frankly, markets know where it’s going and if you strip out their no-deal probability weighting, it’s basically where they expect it too,” he said.
Rate cut bets
The weaker growth outlook comes despite the implicit stimulus from the expectations in markets of a rate cut that the BoE mechanically factors into the forecasts.
Before Thursday’s announcement, markets were pricing in an almost 90 per cent chance that the BoE will cut rates by 25 basis points before Carney steps down at the end of January.
In large part, this reflects the possibility of a significant loosening of BoE policy if there is a no-deal Brexit, to which economists polled by Reuters on average gave a 30 per cent probability.
The European Central Bank is expected to cut rates in September.
The updated BoE forecasts show the central bank expects inflation — currently on target at 2 per cent — to exceed its target in two and three years’ time, and by a greater margin than it predicted in May.
The BoE said growth and inflation would both probably be slower in the case of a smooth Brexit than its forecasts show, due to a likely snapback in sterling and in market interest rate expectations.
Taking this into account, inflation in three years’ time would not necessarily exceed the BoE’s target, but the BoE still foresaw the domestic economy overheating, requiring higher interest rates.