Bank of England stages Brexit dress rehearsal

It is Tuesday 27 June, five days after Britain has voted to leave the European Union.

The pound is falling on the foreign exchanges and share prices are tumbling. Deep inside Threadneedle Street, the nine members of the Bank of England’s monetary policy committee have gathered for an emergency meeting.

The result of the referendum has come as a surprise, intensifying the market turmoil. Polls had suggested a tight race but the assumption had been that the don’t knows would eventually opt for the status quo. The pollsters were wrong.

For months, the Bank has been thinking about what it will do in these circumstances. It has been monitoring whether consumers have been changing their spending habits and whether firms have been mothballing investment plans. But now it is crunch time: the MPC has to decide how to respond to the shock news.

Some members of the MPC point to the impact of the falling pound on inflation. The expectation is that sterling will depreciate by 20%, making Britain’s exports more competitive but pushing up the cost of imports. On balance, the sharp drop in the exchange rate will increase the annual inflation rate at a time when the cost of living has been gradually rising anyway.

Other members argue that the bigger threat is not inflation – still running at below 1% – but the impact on growth. They say the uncertainty about the economic outlook is likely to push down demand in the short term. The economy has been slowing in the run-up to the referendum: now there is a risk it will be tipped into recession.

A dress rehearsal for this debate has already taken place. The minutes from the April MPC meeting suggest that the Bank is fully alive to the risks of Brexit and its knock-on consequences for the economy.

So how would the Bank respond? The minutes talk about “careful judgments” made after weighing up everything from falling asset prices to the likely impact of lower immigration. In truth, the decision would be a relatively simple one: interest rates would be cut.

In part, this would be a confidence-building move. More importantly, it would send out a signal that the Bank was responding to events. Consider what would happen if the MPC sat on its hands after a Brexit vote. Sterling would suffer an even bigger fall; output would take a bigger hit. That’s why it would act: quickly, decisively and probably unanimously.

Powered by article was written by Larry Elliott, for on Thursday 14th April 2016 14.54 Europe/ © Guardian News and Media Limited 2010


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