BoE cuts GDP forecasts and warns of Brexit effect on sterling, growth

As part of its quarterly inflation report, the BoE trimmed its GDP forecast for 2017 to 2.2% from 2.3%, and for 2018 to 2.2% from 2.4%.

The report's calculations were all made on the assumption that the UK will vote to remain a member of the European Union at the June referendum, with the dimmer GDP outlook reflecting the view that productivity and therefore potential supply has deteriorated.

Despite the weaker growth forecast, the outlook for consumer price inflation (CPI) was unchanged at 0.4% for 2016, lowered to 1.5% for next year from its previous 1.6% forecast, and maintained at 2.1% for 2018.

The central bank, whose Monetary Policy Committee meeting on 11 May saw a unanimous vote to maintain the Bank Rate asset purchases, said GDP was likely to have fallen back further in the second quarter as uncertainty around the forthcoming referendum weighs on companies’ and households’ spending.

It stressed heavily that the EU referendum represented the most significant risk to the MPC’s forecast, as "a vote to leave the EU could materially alter the outlook for output and inflation, and therefore the appropriate setting of monetary policy".

As well as households deferring consumption and firms delay investment arising from a potential Brexit vote, it warned "sterling is also likely to depreciate further, perhaps sharply" and altogether lead to a materially lower path for growth and higher inflation than currently assumed.

"In such 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 will depend on the relative magnitudes of the demand, supply and exchange rate effects."

Reaction

Jeremy Cook at World First said: "It seems that the Bank of England sees a fair few reasons to be slightly negative on the UK economy at the moment but none more so than the possibility of a Brexit. Everything about the UK is being viewed through a prism of the Referendum vote, especially the poor data that the British economy has reported in the past quarter or so.

"Indeed, yesterday’s industrial production numbers from the UK which only grew by 0.3% on the month suggested that new orders were being damaged by referendum fears whilst home grown issues such as the National Living Wage and the government’s fiscal consolidation also weighed. You can look at the most recent retail sales and construction output for similar pains in UK industry."

Vicky Redwood at Capital Economics said that while the Bank sounded a loud warning about the potential effects of a Brexit, it continued to stress the key message was that the market’s interest rate expectations are too low.

Commenting on the MPC's rate-setting guidance, Pantheon Macroeconomics highlighted that the committee had tweaked its guidance to say that it thinks 'it is more likely than not that Bank Rate will need to be higher by the end of the forecast period than at present', having previously said 'it is more likely than not that Bank Rate will need to increase over the forecast period'.

"On the face of it, this seems to leave the door ajar to near-term easing, followed by higher rates, perhaps if Britain voted to leave the EU next month."

Barclays felt that in the event of being faced with the 'trade-off' between stabilising inflation and stabilising output and employment, the Committee would look through the spike in inflation and vote for a monetary easing, therefore cutting the Bank Rate to zero and potentially increasing the APF programme to weigh against slowing economic activity.

"However, the [MPC meeting] minutes painted a more finely-balanced picture, highlighting this trade-off; although, with no precision on what said horizon is, one could interpret this as giving the Committee some leeway in judging relative merits of said trade-off and the “relative magnitudes” of the different shocks."