A vote for Brexit is likely to cost jobs, raise prices and could see the pound fall sharply, the Bank of England warned in its quarterly inflation report on Thursday.
In the Bank’s most outspoken comments to date on the consequences of the EU referendum, Mark Carney, BoE governor, warned the risks of a vote to leave “could possibly include a technical recession”.
But the bank’s forecasts also suggest that a vote for Britain to stay in the EU would not see an immediate snap back in economic performance. It reduced its forecast for economic growth for each of the next three years.
Growth is forecast to be just 2.3 per cent in 2017 and 2018, rather than the 2.4 to 2.5 per cent expected in February.
Mr Carney said the “biggest risk to the forecasts concern the referendum” not just because of uncertainty, but the judgement that a vote to leave would have “material effects”.
“We would expect a material slowing in growth”, Mr Carney said.
Although the central bank did not provide a detailed forecast of the consequences of Brexit, its expectation of lower growth and higher inflation would leave it facing a difficult “trade off between stabilising inflation on the one hand and stabilising output and employment on the other”.
Depending on whether the rise in inflation or the rise in unemployment was bigger, interest rates might go up or down, the BoE signalled.
The MPC expects the uncertainty of the referendum itself to hit economic growth in the second quarter of the year, and the bank cut its forecast from 0.5 per cent to 0.3 per cent.
But the BoE made it clear that the effects of a Brexit vote would be much larger. “Households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise,” the MPC said in the minutes to its May meeting, in which there was a unanimous vote to leave interest rates unchanged at 0.5 per cent.
“Sterling is also likely to depreciate further [in a Brexit scenario], perhaps sharply,” resulting in higher import prices and inflation, it said.
In a letter to George Osborne, Mark Carney, BoE governor, said: “It is likely that their combined effect would be to lower growth materially and raise the rate of inflation notably over the MPC’s policy horizon.”
The chancellor seized on these comments as significant support for the Remain campaign, saying that the BoE was offering “one choice [which] would impose costs on families as higher inflation reduced real household incomes; the other choice would impose costs on families with a hit to the economy and to jobs.”
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“This is the kind of lose-lose situation that a vote to leave the EU creates. Either way, Britain would be poorer,” said Mr Osborne.
In its detailed assessment of Brexit, the BoE officials indicated that the effects might be large and amplified by a loss of confidence in foreign financing of the UK’s current account deficit.
“An abrupt decline in capital inflows could pose a major financing difficulty for the UK particularly if it were also associated with investors attempting to reduce their holdings of UK assets,” the bank warned.
In a blow to the chancellor’s hopes, however, the BoE’s forecasts suggested that if there was a vote to Remain in the EU, it may not buoy the economy.
The MPC indicated that interest rates would need to rise if Britain remained in the EU to prevent inflation rising above the 2 per cent target, but when rates began to rise, they would do so “more gradually and to a lower level than in recent cycles”.
The forecast reductions resulted from a tougher outlook for UK households, with the BoE expecting that fiscal consolidation and relatively high household debt levels will cause households to maintain a higher saving rate and spend a little less.
Following unexpectedly weak growth in productivity in the last quarter of 2015, the bank now expects slightly lower productivity growth during the next few years as well.
Despite this slightly weaker outlook for household consumption, the bank still expects private domestic demand to be the main driver of growth over the next few years, as global activity remains subdued and fiscal consolidation continues to depress government spending.
Continuing uncertainty about the outlook for emerging market economies, in particular, means that the bank judges the risks to growth are skewed to the downside.
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