A snapshot suggests the UK economy is currently close to
equilibrium, operating just below potential with inflation just
above its target. Both headline and core inflation are around
2%, and domestic price pressures have been picking up notably.
In particular, the labour market is tight. Growth in wages and
unit wage costs have strengthened considerably as slack has
been absorbed, with both now running at their highest rates in
over a decade.
The strength of the labour market is supporting consumer
spending, which is rising broadly in line with real incomes.
But pictures can deceive; two large, volatile forces could push
the UK economy far from balance. Until the start of this year,
the UK economy had been growing around its trend rate. Since
then, the intensification of Brexit uncertainties and weaker
global activity have weighed heavily on UK activity.
Global momentum remains soft, despite the broad-based easing
in monetary policy expectations. In part this reflects a
significant spike in economic policy uncertainty and the
related risk that protectionism could prove more pervasive,
persistent and damaging than previously expected. These
headwinds are now restraining business investment globally and
could push down on the global equilibrium interest rate,
exacerbating concerns about limited monetary policy space.
Long-term government bond yields have fallen sharply
alongside the falls in expected policy rates. US 10-year yields
are near three-year lows, and 10-year gilt yields and German
10-year bund yields are their lowest ever. Around $16 trillion
of global debt is now trading at negative yields.
As material as these global developments are, the UK outlook
hinges on the nature and timing of Brexit. The UK economy
contracted slightly last quarter (Q2 2019) and surveys point to
stagnation in this one. Looking through Brexit-related
volatility, it is likely that underlying growth is positive but
The biggest economic headwind is weak business investment,
which has stagnated over the past few years, despite limited
spare capacity, robust balance sheets, supportive financial
conditions and a highly competitive exchange rate. There is
overwhelming evidence that this is a direct result of
uncertainties over the UK's future trading relationship with
the EU, and it serves as a warning to others of the potential
impact of persistent trade tensions on global business
confidence and activity. […]
In recent weeks, the perceived likelihood of No Deal has
risen sharply as evidenced by betting odds and financial market
asset pricing (the UK now has the highest FX implied
volatility, the highest equity risk premium and lowest real
yields of any advanced economy).
In the event of a No Deal No Transition Brexit, sterling
would probably fall, pushing up inflation, and demand would
weaken further, reflecting lost trade access, heightened
uncertainty and tighter financial conditions. Unusually for an
advanced economy slowdown, there would also be a large,
immediate hit to supply. The Monetary Policy Committee (MPC)
would need to assess to what extent that reflects temporary
disruption to production, with limited implications for
inflation in the medium term, or a fundamental destruction of
supply capacity because of the abrupt change in the UK's
economic relationship with the EU.
As the MPC has repeatedly emphasised, the monetary policy
response to No Deal would not be automatic but would depend on
the balance of these effects [...].
Excerpt from Mark Carney's 'The Growing Challenges for
Monetary Policy in the current International Monetary and
Financial System' speech, given at the Jackson Hole Symposium
2019, August 23 2019. All speeches are available at www.bankofengland.co.uk/news/speeches.