The Bank of England (BoE) has held interest rates at 0.75%, but the Bank warned there is a one-in-three chance of the economy shrinking at the start of 2020.
Brexit is taking its toll and the Monetary Policy Committee (MPC) said the heightened no-deal Brexit worries has seen uncertainty as firms are becoming “more entrenched” affecting the wider economy.
The MPC unanimously voted to keep rates unchanged and accompanying the quarterly inflation report the Bank has cut growth forecast by 1.3% for this year and next. This is down from the previously predicted 1.5% and 1.6%.
The BoE has further warned the predicted 33% chance of annual growth falling below zero during the first quarter of 2020, with or without a cliff edge exit from the EU.
The MPC said that in the event of a no-deal Brexit “the sterling exchange rate would probably fall; CPI inflation would rise and GDP growth slow.”
They reiterated that interest rates could fly in either direction as the Bank will need to balance and cool inflation as the pound plunges.
Since the BoE’s last inflation report in May, the pound has plummeted by 6% as a no-deal Brexit is mounting.
Businesses are holding back on investment affecting growth over Brexit uncertainty, the Bank now expects the gross domestic product (GDP) to flatline during the second quarter. This is down from 0.5% of growth from January to March.
The UK growth outlook has been upped to 2.1% for 2021.But the Bank admitted the forecasts are skewed as financial markets are predicting a rate cut to 0.5% in the first half of 2020 as they believe there is a 50/50 chance of there being a no-deal.
If there is a smooth Brexit and the global economy recovers, there will be a “gradual and “limited” rise in rates required, the MPC said.
The BoE said in the minutes, “Increased uncertainty about the nature of EU withdrawal meant that the economy could follow a wide range of paths over coming years.”
They added, “The monetary response to Brexit, whatever form it took, would not be automatic and could be in either direction.”
Even is a deal is reached with the EU recent surveys have indicated that businesses expect investment to remain weak for the next year, the report showed.
Ranko Berich, Head of Market Analysis at Monex Europe said, “Carney and the MPC have clearly decided not to follow the FOMC down the path of “insurance” rate cuts, despite the worsening risks of no deal and what was probably a dismal second quarter for the economy. Rising Brexit risks got a brief nod, but Carney was happy dismissing no-deal as outside the Bank of England’s base case, which still assumes a smooth transition.
“There is an interesting contrast between how the MPC and FOMC are dealing with increased political uncertainty, with Carney and the MPC happy to take note of downside risks while sticking with a relatively optimistic base case and leaving policy unchanged. The FOMC, on the other hand, has been happy to cut due to a worsening in the balance of global risks, partly due to politics. The difference is largely due to higher inflation in the UK, and the FOMC facing lower risks of a rate cut due to the buffer they have built up over the course of their previous hiking cycle.
“The BoE has upgraded its growth forecasts and said again that tightening will probably be necessary. The fact that sterling hasn’t rallied even slightly shows the extent to which the BoE’s assumption of a smooth Brexit is being completely rejected by markets, which remain focussed on the growing and serious risk of no-deal.”