Brexit uncertainty spurs Bank of England to cut UK growth forecasts

Policymakers hold rates steady but see 1 in 3 chance of economy shrinking in early 2020

Brexit uncertainty and global trade tensions are hitting UK growth, with the Bank of England’s forecasts showing a one-in-three chance that the economy will shrink at the start of next year.

In its August inflation report, the bank cut its central forecast for growth this year and next, predicting output would rise just 1.3 per cent in both 2019 and 2020 even if it were to cut interest rates as markets have been expecting. The BOE had previously forecast in May that output would grow by 1.5 per cent and 1.6 per cent respectively.

It added there was a 33 per cent probability of negative growth in the first quarter of 2020 if interest rates remained unchanged — the highest chance of a contraction it has seen since the immediate aftermath of the Brexit referendum in August 2016.

Mark Carney, the BOE governor, dismissed suggestions that it was guilty of adopting the “gloomster” attitude decried by the new

prime minister Boris Johnson.

“It is clear the level of uncertainty is affecting business,” Mr Carney said. “It is also clear there has been a substantial shortfall in investment. It is beginning to become clear that the trade response to lower sterling has begun to fade . . . these consequences are there.”

But in contrast with the US Federal Reserve and European Central Bank, the BOE shows no signs of responding to the weakening outlook by cutting interest rates. Instead, the Monetary Policy Committee voted unanimously to hold rates at 0.75 per cent, and signalled that borrowing costs would eventually need to rise to keep inflation at its 2 per cent target — given an orderly Brexit and a recovery in global growth.

It also stuck to its collective position that interest rates could move in either direction in the event of a no-deal Brexit.

The Boe’s central forecasts, premised on a smooth Brexit that would boost the economy, show inflation overshooting its target by a significant margin, rising to 2.4 per cent on a three-year horizon. The forecasts also show a strong rebound in growth, which rises to 2.3 per cent in 2021 — above the May forecast.

But the bank acknowledged that these forecasts were of little practical use at present, since they are built on the prevailing market exchange rate and on market expectations of the path of interest rates.

In contrast with the BOE, investors are factoring in an increasing risk of a disruptive Brexit. They have assumed that policymakers would respond to this by cutting interest rates, with a quarter point increase priced in by the end of this year. Both this, and the recent sharp depreciation in sterling, result in a higher forecast for inflation.

Since Mr Johnson entered Downing Street last week, he has instructed ministers and officials to “turbocharge” no-deal preparations and on Thursday the chancellor Sajid Javid announced £2.1bn in extra funding to prepare for the UK crashing out of the EU on October 31.