The Bank of England has retreated from plans for multiple interest rate rises as it sharply downgraded its economic outlook amid mounting Brexit uncertainty and slowing global growth.
In one of the largest near-term forecast revisions since the 2016 EU referendum, the central bank cut its forecast for UK growth to 1.2 per cent in 2019, the weakest level since the recession of 2009. As recently as November, the bank had expected 1.7 per cent growth this year.
The statement initially sent sterling sinking to a low of the day, but it recovered in afternoon trading as markets saw the BoE’s statements and forecasts as a holding statement until greater clarity on Brexit emerged.
The BoE’s forecasts and governor Mark Carney’s commentary was significantly more downbeat on the economy than economists expected. It allied the central bank with its counterparts in the US, India, Australia and Canada who have all stepped back from plans for tighter monetary policy and highlighted concerns about the economic outlook.
The BoE’s central forecast is for the UK to avoid a recession, but with only 0.2 per cent growth forecast for each of the first two quarters of the year, half the rate it previously thought.
It forecast a significantly higher chance of Britain sliding into recession this year, putting the odds at one in four that the UK’s annual growth rate will have dipped below zero by the summer even assuming a “smooth” Brexit process.
Mr Carney said this risk of recession would rise significantly if Britain left the EU in March without a deal and with no transition arrangements. “When the economy is growing more slowly, the probability of having a negative quarter or two goes up . . . and if there is a shock — a no-deal, no-transition Brexit would be a shock — that further increases the possibility of negative quarters,” he said.
Much of the BoE’s gloom stemmed from much weaker business investment that the bank had been expecting. Officials blamed “softer activity abroad and the greater effects from Brexit uncertainties at home” for the forecast downgrades and the more dovish attitude to interest rates.
The BoE expects business investment to drop 2.75 per cent this year, having previously expected growth, blaming Brexit uncertainty, which has led “around half” of the companies surveyed by the central bank to implement contingency plans for a no-deal Brexit without any transition at the end of March.
These forecasts would be significantly worse if Britain left the EU abruptly next month. “The economy as a whole is still not yet prepared for a no deal, no transition exit,” Mr Carney said. He added that there were now signs that in addition to companies holding back on investment and there were signs that the caution was spreading to households.
“Indicators suggest spending growth has been modest since the start of the year,” the governor said.
In the face of the significantly weaker outlook, the Monetary Policy Committee indicated it was much less likely to raise interest rates. It voted unanimously to hold the benchmark rate at 0.75 per cent in the February meeting.
The committee’s forecasts showed little concern about rising inflation even if it kept rates on hold for the next three years. They illustrated that policymakers thought there was only a 56 per cent probability that inflation would exceed the BoE’s 2 per cent target after two years if it left rates unchanged with a weaker inflation profiles than in the November forecasts.
David Page, senior economist at Axa Investment Managers, said the new forecasts “suggest the BoE will be in no hurry to raise rates”.
Andrew Goodwin, associate director of Oxford Economics, said “the sands do now seem to be shifting” on the MPC’s hawkish rhetoric even though the committee decided to repeat its rhetoric that there would be “limited” and “gradual” interest rate rises to come.
The forecasts suggest the MPC believes that at most a one quarter-point interest rate rise is required over the next three years to keep inflation under control
Allan Monks of JPMorgan was one of a number of City economists to push back previous forecasts of the next quarter-point rate rise from May to August and acknowledged “the risks around this are still skewed towards a later tightening”.
On financial markets, traders who make markets on future interest rates on a new CME market predicting BoE actions now think it is more likely than not that the central bank will not raise rates at all this year.
Highlighting internal worries about the accuracy of its forecasts, BoE staff published alternative scenarios for the economy on the basis that uncertainty over Brexit became even more acute and subsided faster than it expected.
They showed that if uncertainty grew over the Brexit outcome, growth would be significantly weaker by up to 1.5 per cent over three years, but if uncertainty could be resolved quicker than it currently expects, there could be an equivalent dividend, alongside higher inflation and interest rates.