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Bank of England predicts one in three chance of recession as Brexit uncertainty hurts business

It’s a hold. Again. In the face of intensifying uncertainty surrounding Brexit, the Bank of England has decided to sit on its hands, making it pretty clear that interest rates are unlikely to move up or down until the nature of our departure from the European Union has become clearer.

The Bank of England continues to assume that Brexit will basically turn out alright, that a deal with the EU will be struck and that Britain will make a “smooth adjustment to the average of a range of possible outcomes for the United Kingdom’s eventual trading relationship with the European Union”.

It’s an increasingly brave assumption, because the financial markets are starting to believe that Brexit will be anything but smooth. The pound has fallen by almost 6% since May, long-term interest rates have tumbled too.

Three months ago, investors had baked in two interest rate rises in the next three years, they now expect an interest rate cut in 2020. Slowing global growth has helped to change sentiment but an assumption that it’s looking increasingly probable that Britain departs the EU without a deal in two months’ time has played its part. What a difference a new prime minister makes.

Of course, Boris Johnson says no-deal is a “million to one” shot but Michael Gove assumes it will happen and the new chancellor, Sajid Javid, is busy spending £2 billion preparing for a hard Brexit. The betting markets estimate the probability of no-deal at around 35% and rising.

What’s the Bank of England’s view? We don’t know and they won’t tell us.

Chancellor Sajid Javid has set aside £2 billion to prepare for a hard Brexit. Credit: PA

The Bank does say that in the event of no-deal the pound will fall, inflation will rise and growth will slow, but for now they refuse to include no-deal in their forecasts.

The tension between what the Bank assumes will happen next and what the market’s increasingly suppose makes for a rather messy Inflation Report, as asset prices influence the Bank’s forecasts.

Even with a smooth Brexit, the Bank has downgraded its growth forecasts for this year (1.3%) and next (1.3%) although it imagines that the economy will bounce back robustly in 2021.

The weaker pound and lower interest rates combine to push up prices. The Bank expects inflation to reach 2.5% by the end of 2022 - well above its target rate of 2%.

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The record number of people in work and strong pay growth continue to support economic growth. Amid the uncertainty, British households continue to spend merrily. However, British businesses are in a state of high anxiety. It is clear beyond doubt that Brexit has had a massive negative effect on business investment, which is more than 20% lower today than the Bank was assuming before the referendum.

The Bank estimates that the economy flatlined between April and June of this year as no deal stockpiling unwound and car makers brought forward their summer factory shutdowns. These should be temporary events but the Bank notes what it calls “underlying” economic growth has weakened. The Bank believes the probability the UK is heading for recession has increased. It estimates the likelihood that growth at the beginning of 2020 will be zero or lower at 30% - the highest since the referendum.

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