Calm Before the Storm

1 November 2018


Cogito Ergo Non Serviam

Bank of England Holds Pre-Brexit Rates Steady


The Bank of England's Monetary Policy Committee voted 9-0 today to keep interest rates in the UK steady. The official bank rate remains at 0.75%, the level to which it was raised in August. This decision suggests that there will be no increase in rates until after Britain leaves the European Union at the end of March next year. When that happens, all bets are off because the direction of the economy will largely follow the terms of the departure rather than the usual drivers of an economy. Under the best circumstances, one doesn't expect an increase in the first few months outside the EU.

The Bank came right out and said Brexit will condition future economic activity. "The key risk to near-term growth is the extent to which uncertainty about Brexit affects spending as negotiations with the EU continue," the Bank of England said in its Quarterly Inflation Report. Because of this, the BoE expects no increase in business investment this year. That means there will be lower growth than there would otherwise have been without Brexit concerns.

The BoE expects GDP to rise 1.3% this year and 1.7% next year. The predictions rest in large part on rising wages, always a sign of economic health, which are growing at their fastest pace in a decade. For the quarter ended August 30, 2018, GDP in the UK was up 0.7%.

This journal thinks these predictions are too rosy. The BoE covered its collective backside in the Quarterly Inflation Report with this caveat, "an abrupt and disorderly withdrawal [from the EU] could result in delays at borders, disruptions to supply chains, and more rapid and costly shifts in patterns of production, severely impairing the productive capacity of UK business."

Given the ineptitude of the minority-Tory government in negotiations with Brussels thus far, it's safe to say the withdrawal will be both abrupt and disorderly. The inability of anyone to solve the problem of the Irish border alone is enough to sink the discussions.

Dr. Simon Usherwood, a reader in politics at the University of Surrey, told the Independent, "On 29 March next year, the UK would leave the EU and everything associated with that would come to an end. . . . [A no-deal Brexit] doesn't stop the UK leaving but it means there is absolutely no clarity about what happens."

Clarity is what businesses like most, second only to tax cuts. Making decisions about products and services is hard enough when a CEO knows exactly what the rules are going to be. When the rules are in doubt, successful decisions are as much a matter of chance as they are of strategy.

If a 1.7% increase in GDP is the upper limit for the UK should Brexit go swimmingly, a less-than-optimum version is certain to result in a growth rate below that. This journal believes that any deal at this point is unlikely, and if there is one, it will be a bare-bones compromise that papers over the problems. The ramifications are unpleasant in the extreme.

If there is no deal, then lower GDP growth for 2019 is included in the future almost by definition. A weaker pound is almost certain as well because capital will not be flowing into Britain because of the uncertainty, and if capital inflows decline, fewer investors need to buy pounds to do their investing so the value of the currency drops.

That would place the BoE on the horns of a nasty dilemma. A falling currency will drive up the cost of imports, which figure heavily in the UK's economy because it has been part of the EU for so long. That will produce inflation, which the BoE is tasked with keeping below 2%. Higher interest rates should logically follow to defend the pound. Higher interest rates will also serve to slow economic growth. That's fine if GDP is growing at 5% and inflation is rising, but at 1.7% maximum, tapping the brakes with higher interest rates will hurt. The BoE will be damned if it does, and damned if it doesn't. One expects something akin to a deer-in-the-headlights reaction through the spring.

On the whole, it would be better to Remain.

© Copyright 2018 by The Kensington Review, Jeff Myhre, PhD, Editor. No part of this publication may be reproduced without written consent. Produced using Ubuntu Linux.

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