The Bank of England warned that damage to the economy from Brexit has increased as it cut its growth forecast and predicted a dramatic slump in investment.
As the U.K. approaches the March 29 deadline to leave the European Union without yet having a deal for a new relationship settled, businesses are slashing spending and consumers are growing more worried.
The BOE said that “uncertainty had intensified,” and now forecasts 1.2 per cent growth this year, down from 1.7 per cent predicted three months ago, the biggest downgrade since the 2016 referendum. The global backdrop has also weakened, as highlighted in the European Commission’s sweeping cuts to the euro-area economic outlook on Thursday.
The BOE’s decision follows recent dovish statements from the U.S. Federal Reserve and European Central Bank. U.K. officials noted the impact of China’s slowdown and said trade wasn’t contributing as much to growth as they expected.
The forecasts came alongside the latest policy decision by the Monetary Policy Committee, led by Governor Mark Carney. It voted 9-0 to hold the key interest rate at 0.75 per cent, as predicted by all economists in a Bloomberg survey. The bank last lifted the rate in August.
With Brexit hanging over the outlook, the bank said that its forecasts would need to be updated “once greater clarity emerged about the nature of EU withdrawal.” Acknowledging the huge impact of uncertainty, it ran an analysis showing that less uncertainty would lead to much stronger growth -- 1.6 per cent this year and 2.2 per cent in 2020.
Assuming a smooth Brexit, policy makers reiterated that limited and gradual rate increases will be necessary. Nevertheless, the forecasts suggested that just one more quarter-point hike would be needed in the next three years to return inflation to close to the 2 per cent target, down from almost three hikes seen in November.
Investors now see almost no chance of a quarter-point rate move by the end of the year.
The bank said that productivity is recovering more slowly than it had thought and that the supply capacity of the economy had shrunk. Officials said that potential supply growth is now a “little below” the 1.5 per cent previously estimated.
In two years, officials see demand outstripping supply, implying some inflationary pressure building in the economy. In the near- term, inflation will drop below the BOE’s 2 per cent goal due to lower oil prices.
Policy makers cut their prediction for business investment to a 2.75 per cent drop this year, having previously seen a 2 percent increase. They still see it recovering thereafter.
The committee noted how sensitive its forecasts are to swings in the pound. A 5 per cent depreciation in sterling would lift inflation to 2.4 per cent by the end of 2021 -- versus 2.1 per cent in the current projections -- while a gain of that magnitude would drop the rate to 1.8 per cent.
--With assistance from Harumi Ichikura