No UK interest rate rise but plenty of no-deal Brexit warnings

The Bank of England warning aims to focus MPs’ minds on getting a Brexit deal done. Project Fear Mk II might just work

Picture the scene. The UK economy is in turmoil after the government fails to reach a Brexit deal with the EU. Amid fears of a looming recession, the Bank of England turns the screw by raising interest rates.

Unlikely? Not according to Threadneedle Street, which has warned there is no guarantee that it would respond to the shock of a no-deal Brexit by reducing borrowing costs, which was what it did in the aftermath of the referendum in 2016.

Lenders have already bumped up the cost of fixed rate mortgages ahead of the Bank of England’s decision to raise base rate from 0.25% to 0.5%, and mortgage borrowers on tracker and variable rates will see their monthly payments become more expensive in the coming days. ​

Savers will gain as banks and building societies improve the rates available on deposit and Isa accounts, although increases are unlikely to come for several weeks.

How much consumers and businesses cut back on spending and investment in the face of higher rates will depend on signals from the Bank about the trend for future increases.

This time, the Bank stressed in its quarterly inflation report, the decision could go either way. Its argument goes as follows. Back in 2016, inflation was below the government’s 2% target and now it is above it. Any spare capacity in the economy has been used up over the past two and a half years and the labour market is tight.

A no-deal Brexit will have an impact on demand in the form of weaker consumer spending and lower investment, which would give the Bank’s monetary policy committee a reason to cut rates.

But it would also have an impact on the economy’s supply side. There might be labour shortages, disruption at the border, and firms could shift production overseas. All that would mean the growth rate at which the economy could operate without triggering higher inflation would be lower. That would point to higher interest rates to prevent inflation from taking off.

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As such, the Bank’s response would depend on whether the hit to demand was bigger or smaller than the hit to supply. The decision would not be automatic and could go either way.

The idea that the MPC would actually kick the economy on the way down is highly implausible. It is the equivalent of George Osborne saying before the referendum that there would be an emergency budget to raise taxes and cut spending by £30bn in the event of a vote to Leave.

But Osborne was trying to influence millions of voters; Mark Carney and his MPC colleagues are seeking to concentrate minds among a much smaller constituency: the policymakers negotiating a deal and the MPs who will eventually vote on it. Which is why Project Fear Mk II might just work.


Larry Elliott

The GuardianTramp

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