Brexit is biggest risk to UK economy, warns Bank of England

Bank Of England Building

A vote to leave the EU risks sending the pound sharply lower, stoking inflation, raising unemployment and denting economic growth, the Bank of England warned as its policymakers voted unanimously to keep interest rates at their record low.

Describing the 23 June referendum on EU membership as “the most immediate and significant risk” for the UK’s economic outlook, the central bank said it would face a difficult balancing act in deciding whether to cut, hold or raise interest rates in the aftermath of a vote to leave the bloc.

Updating financial markets against the backdrop of tight opinion polls, the Bank’s policymakers warned that in the event of a so-called Brexit they would have to react to opposing forces of lower growth and higher inflation because a fall in sterling would raise import prices.

Publishing a swath of documents, including minutes to the latest rate-setting meeting and new quarterly forecasts, the Bank made its most forthright remarks yet on the possible impact of a leave vote. With the referendum clouding the economic outlook and weighing on business confidence, the Monetary Policy Committee’s (MPC) nine members all voted to leave rates at 0.5%.

The minutes revealed the MPC discussed the implications of both a vote to remain in the EU – currently seen as the more likely outcome based on polls – and a vote to leave.

“A vote to leave the European Union could materially affect the outlook for output and inflation. In the face of greater uncertainty about the UK’s trading relationships, sterling was likely to depreciate further, perhaps sharply,” the minutes said.

“In addition, households could defer consumption and firms could delay investment decisions, lowering labour demand and increasing unemployment.”

The Bank noted the pound had already depreciated 9% since a November peak and that half of that was down to the “risks associated with a vote to leave the European Union”.

The minutes echoed remarks made by Chancellor George Osborne that the Bank would face a trade-off when setting policy after a leave vote. Speaking to MPs on Wednesday, Osborne also conceded for the first time that the Treasury and the Bank of England were carrying out detailed contingency planning to prevent a leave vote unleashing a financial crisis.

Thursday’s Bank minutes said that taken together, the combination of movements in demand, supply and the exchange rate “could lead to a materially lower path for growth and a notably higher path for inflation”.

“In those circumstances, the MPC would face a trade-off between stabilising inflation on the one hand and output and employment on the other. The implications for the direction of monetary policy would depend on the relative magnitudes of the demand, supply and exchange rate effects.”

The Bank’s Governor Mark Carney further expounded the risks of a leave vote in a letter to Osborne, one of the leading figures in the campaign to remain in the EU. The letter was the latest in a series, regularly sent to explain why inflation was still far below the Bank’s government-set target of 2%.

Carney has already incited criticism from some Brexit campaigners, who feel his comments on the referendum go beyond the Bank governor’s remit. He is likely to face fresh disapproval for the letter to Osborne.

Carney wrote: “A vote to leave the EU could have material economic effects – on the exchange rate, on demand and on the economy’s supply potential.”

Osborne seized on Carney’s remarks in his reply, summarising that the Bank’s assessment showed “Britain would be poorer” in the event of a Brexit.

“As you point out in your letter, the EU referendum is already having an effect, and that uncertainty is beginning to weigh on economic activity,” Osborne wrote.

On the Bank’s predicted trade-off, the chancellor added any outcome would “impose costs on families”. “The is the kind of lose-lose situation that a vote to leave the EU creates.”

But Carney and the Bank’s latest outlook was careful to note that there were factors weighing on the UK economy beyond next month’s referendum. Those included the state of households’ finances against the backdrop of further government cuts, the outlook for the UK’s relatively weak productivity performance and the prospects for the global economy.

The Bank also warned against expecting a rapid rebound in economic activity in the event of a vote to stay in the EU. “It was possible that there would be a more prolonged drag on business spending if delayed projects took time to be re-started,” the minutes said.

The Bank’s Inflation Report set of forecasts showed its view of the global economy had changed little since the last report in February. But it cut the outlook for the domestic economy, to GDP growth of 2% this year, down from 2.2% pencilled in back in February. Forecasts for further out were also weaker as the Bank felt households would be less willing than previously thought to drive down savings in order to spend.

Powered by Guardian.co.ukThis article was written by Katie Allen, for theguardian.com on Thursday 12th May 2016 12.15 Europe/Londonguardian.co.uk © Guardian News and Media Limited 2010

 

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