UK inflation announcement: Bank of England forecasts record rise over Hard Brexit fears

The Bank projects consumer price inflation rising to 2.7 per cent in the final quarter of 2017

Ben Chu
Thursday 03 November 2016 12:53
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Mark Carney has said the Article 50 ruling will only add to uncertainty
Mark Carney has said the Article 50 ruling will only add to uncertainty

Inflation will rise close to three per cent by the end of next year thanks to the plunge in the pound and fears of a “hard” Brexit according to the latest forecasts from the Bank of England today.

And in an indication that the Bank may be forced to jack up interest rates considerably sooner than markets currently expect the Bank’s Monetary Policy Committee [MPC] stressed “limits to which above-target inflation could be tolerated”.

The Bank warned the rise in inflation and the plunge in the currency was due to a “shock to future supply” in the UK economy brought on by fears the UK is now heading out of the EU single market.

Carney: Article 50 ruling adds to uncertainty

In its latest round of forecasts the Bank projects consumer price inflation rising to 2.7 per cent in the final quarter of 2017, up from 2 per cent in its August forecasts.

And it sees inflation still at 2.5 per cent in 2019. This is the biggest overshoot over three years relative to the Bank’s official 2 per cent target the MPC has ever projected in an Inflation Report.

The current rate of inflation is 1 per cent and many retailers have warned that prices of goods in the shops will soon have to rise due to the major jump in their import costs.

Though the Bank said inflation expectations “remain well anchored” its stress on the “limits” to its inflation tolerance will send a hawkish message to the financial markets on the likely future path of its policy rate.

As widely expected, the 9-person Monetary Policy Committee voted unanimously to keep interest rates on hold at 0.25 per cent.

The Bank had previously signalled a further cut in its policy rate to 0.1 per cent but the economy has performed considerably better than the Bank forecast in August, growing by 0.5 per cent in the third quarter of the year, defying expectations the economy could fall into recession in the wake of the vote to leave the EU.

The Bank now expects this growth to continue, pencilling in a further 0.4 per cent of GDP growth in the final quarter of the year. It had previously forecast growth close to zero for the second half of this year.

And it has upgraded its 2017 GDP forecast to 1.4 per cent, almost double its August forecast of 0.8 per cent.

Nevertheless, the overall cumulative growth forecast over the three year forecast period is still weaker than in August – which was itself a record cumulative growth downgrade – in an indication the Bank still firmly believes Brexit will inflict a serious negative toll on the economy.

The Bank said sterling’ lurch down against the dollar in October was due to market “perceptions that the UK’s future trading arrangements with the EU might be less open than they previously thought likely”.

Sterling started falling again at the beginning of last month after the Prime Minister Theresa May indicated she would trigger the 2-year Article 50 EU divorce process in March 2017 and would prioritise controlling immigration from the EU.

This is understood to imply Britain would have to leave the EU single market, usually described as a hard Brexit.

The Bank’s growth forecast in 2018 is 1.5 per cent, down from 1.8 per cent in August. And growth in 2019, the year the UK is expected to officially leave the European Union, is only 1.6 per cent.

The Bank still expects the unemployment rate to rise to 5.6 per cent in 2018, up from 5 per cent today.

The Bank expects business investment growth of just 2 per cent in 2018, less than half the 4.75 per cent growth it expected in August.

It cited firms’ likely fears “their access to EU markets could be materially reduced”.

The Bank expects the trade-weighted sterling exchange rate – which has fallen more than 15 per cent since the Brexit vote and 6.5 per cent since October – to remain steady over the coming three years.

Many City economists, however, think the currency has considerably further to fall, something that would inevitably exert more upward pressure on domestic inflation.

This week the National Institute of Economic and Social Research forecast that inflation will jump to almost 4 per cent next year, well in excess of the Bank’s current projection.

Adam Posen, a former member of the Bank’s MPC, has voiced fears that a much bigger than expected increase in inflation could prompt the Bank to put up rates as soon as next May.

The Bank said the “limits” on its toleration for inflation overshoots would depend on the cause of the rise, signalling if there were signs of inflation expectations becoming unanchored it would act.

The MPC also voted unanimously to continue with its £10bn corporate bond and £60bn Gilt buying programme designed to help the economy weather the Brexit vote.

The Bank said the impact of its latest money printing programme had had a slightly larger impact on financial markets than it expected.

In August the Bank had said its monetary stimulus was one of the reasons the UK would avoid a return to recession.

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