Britain has a one in three chance of plunging into recession at the start of next year as the heightened uncertainty over Brexit drags down the economy, the Bank of England has warned.
The central bank said business investment was stalling, with trade tensions and slowing demand in the global economy also having an impact on UK growth.
Britain has a 33% probability of falling into recession by the end of the first quarter of 2020 even if a Brexit deal is reached, the bank said, because of the impact from heightened uncertainty.
Mark Carney, the Bank’s governor, said that Britain crashing out would cause an “instantaneous shock” to the economy that would be tough for the central bank to respond to. He warned the pound would be sold off sharply, inflation would rise, while GDP growth would slow further.
“We will do what we can in those circumstances to support jobs and activity. But there are limits to what we can do,” Carney said.
The intervention from Threadneedle Street comes as the pound continued to slide on the international currency markets on Thursday, as the chance of Britain crashing out of the EU at the end of October rises. Sterling fell by 0.2% against the US dollar to $1.2135 and by 0.1% against the euro to €1.0964.
Boris Johnson has ramped up the rhetoric to warn that Britain would be prepared to walk out of the EU without a deal in 91 days’ time, sending sterling tumbling to the lowest levels in more than two years.
Since his elevation to No 10, the pound has crashed below $1.22 against the US dollar and €1.10 against the euro, notching up the worst performance of any major currency in the world over the month of July.
“These asset prices reflect market participants’ perceptions of the likelihood and consequences of a no-deal Brexit,” the Bank said.
The pound was also knocked on Thursday by a closely watched manufacturing survey, which showed that output in the sector fell at the fastest pace in nearly seven years in July.
Against the deteriorating UK backdrop, the Bank’s nine-member monetary policy committee (MPC) voted unanimously to leave interest rates on hold at 0.75% on Thursday.
Publishing its quarterly inflation report, the MPC said it expected zero GDP growth in the second quarter of this year, between April and June, “reflecting more entrenched Brexit uncertainties”. It downgraded its forecasts for growth this year and next to 1.3% from a previous estimate of 1.5%, in a development that would mark the weakest economic expansion since 2012.
Despite the growing risks to the economy, the Bank said it continued to assume a smooth Brexit deal with Brussels could be reached – a position it acknowledged was increasingly inconsistent with financial market perceptions.
Market expectations of a no-deal Brexit have risen sharply since Johnson has come to power, with the probability rising to almost 40%, up from about 15% in April.
Carney said the central bank made forecasts based on official government policy, even if the financial markets were now indicating the chance of no deal has risen. While the Bank has not published a forecast for no deal, he warned it would be an “unwelcome development” for Britain and the rest of the world.
Although Johnson still has an ambition to strike a new deal with Brussels, several members of the government, including Michael Gove, have suggested that no deal is starting to become an “operating assumption”. The EU has also indicated a lack of willingness to reopen Theresa May’s withdrawal agreement for negotiation.
Despite the impact Brexit uncertainty is having on the economy, the Bank’s governor said the best way to provide clarity for households and businesses was not to push for a no-deal departure.
“No deal as a crystallisation of a bad economic outcome is not preferable to the possibility of a better economic outcome,” he said.
Should Brexit pass smoothly, the MPC suggested that interest rates would need to rise to combat rising inflation over the next three years. Under its core forecast, based on a deal being agreed, inflation would rise to about 2.4% from a current level of 2% within three years. The Bank has a target to steer inflation towards 2% set by the Treasury.
“Assuming a smooth Brexit and a recovery in global growth, a significant margin of excess demand was likely to build,” the Bank said, adding: “Were that to occur, the MPC judged that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate.”
