UK Central Bank Statement

Author: IFLR Correspondent | Published: 24 Sep 2019
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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 muted.

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.