Bank of England holds interest rates but warns no-deal Brexit may force them up

Threadneedle Street holds base rate at 0.75 per cent and forecasts growth of 1.3 per cent this year, rising to 1.7 per cent in 2019

The Bank of England said it would not be able to cushion the blow of a no-deal Brexit (EPA)

The borrowing costs of UK households and businesses may rise in the event of a no-deal Brexit, the Bank of England has warned.

The central bank stressed that it may not be able to cushion the economic blow of the UK crashing out of the European Union next March with no agreement.

The warning piles pressure on to MPs to avoid the scenario at all costs and undercuts the arguments of some hardline Brexiteers that a no deal is nothing to fear.

In the Bank’s Inflation Report, published on Thursday, it emphasised that financial markets – and the public – should not assume it would ease the cost of credit after a messy breakdown of EU negotiations.

“The [Monetary Policy Committee] judges that the monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction,” it said.

After the surprise Brexit referendum result in 2016 the MPC slashed its policy rate to a historic low of 0.25 per cent, despite making a similar argument before the vote that rates could go either way in the event of a Leave result. But the Bank warned that conditions now were very different.

“The current situation differs materially from that on the eve of the referendum,” said the Bank’s Governor Mark Carney. “The economy is now broadly in balance, rather than in being material excess supply as it was then. Inflation is notably above target, not significantly below.”

The Bank also stressed that a no deal would “probably” cause another slump in the pound, pushing up domestic inflation and bolstering the case for borrowing costs to rise.

After the referendum, sterling suffered a record one-day fall against the dollar.

However, in a press conference, Mr Carney conceded that it would be difficult for the MPC to determine, in the circumstances of a chaotic Brexit, how much of the economic damage reflected a hit to economic supply (which would support the case for higher rates) and how much to demand (which would support a cut).

“It will be a challenge without question,” he said. “What’s temporary? What’s more persistent? And the relative balance of that versus what would be expected [to be] a hit to demand.”

The MPC, as universally expected by markets, left interest rates on hold at 0.75 per cent on Thursday.

But it presented a relatively hawkish set of projections, saying slack had now fully disappeared from the UK economy and that inflation was set to be slightly above the official 2 per cent target, under current market interest rate expectations, by 2021.

Markets are now pricing in the next rate hike at the end of 2019 and another in early 2021.

The Bank noted that average pay excluding bonuses in the third quarter of 2018 was up 3.1 per cent year-on-year, higher than its expectation in August of 2.6 per cent.

The latest forecasts were also compiled before the government’s Budget on Monday. The increased public spending for the NHS next year and the cut in income taxes is likely to have a positive near-term impact on UK demand and therefore on inflationary pressures.

The Bank predicts growth this year will be 1.3 per cent, rising to 1.7 per cent in 2019 – similar to its last report in August.

“The MPC has indicated to markets that interest rates will need to rise at least three times in the next three years if a Brexit transition deal is signed off soon,” said Samuel Tombs of Pantheon.

“Given that the MPC already thinks that the output gap has closed and excess demand will emerge in 2019, it will judge that it needs to accelerate its tightening plans to prevent the fiscal stimulus from fuelling inflation.”

Yet this is all based on a smooth Brexit and the UK entering a 21-month transition period, where it remains in the single market and customs union.

The Bank presented other survey research showing that Brexit is the largest headwind to firms’ investment. Official data on business investment has also been weaker than it expected three months ago, consistent with rising concern over the possibility of no deal. The Bank also highlighted that traders have been increasing their bets on a large depreciation of sterling over the next six months.

The Bank’s Governor, Mark Carney, has told the Treasury Select Committee that it will publish formal no-deal economic scenarios before MPs have their “meaningful vote” on any Brexit deal the Government produces.

Mr Carney reportedly told the cabinet earlier this year that its 2017 banking stress tests assumed a 33 per cent hit to house prices, which could be similar to the aftermath of a no deal.