Central bankers in general have to live with unpredictability. But as much as possible, they prefer risks they can quantify. Monetary policy never deals with the certain, but it is relatively comfortable when handling known “unknowns”. What central bankers find very difficult to deal with is the kind of risk to the UK economy posed by the chance of a no-deal Brexit. Potential outcomes are discrete and the impacts very widely. The full chaos of an unplanned crash out of the EU without even emergency measures to keep goods crossing borders would be very different from a long extension of the Article 50 exit process, or indeed the revocation of Article 50.
When the Bank of England monetary policy committee publishes it latest forecast and announces its decision on interest rates, it will have to grapple with the question of exactly how to address such uncertainty. Officially, since it premises its forecasts on government policy of a smooth Brexit at the end of March, the Bank of England will not incorporate a dramatic effect from the event into its forecasts.
In reality, given the real potential for a crash landing, the Bank of England would be remiss if it did not at least signal that it would keep rates down until some uncertainty clears. It must also stand ready to react to any shock of confidence. It is perhaps surprising that financial markets, which are not bound by any convention of incorporating government policy into their forecasts, are not pricing in more of a risk of a hard Brexit. A nasty surprise in our opinion could see some serious market corrections. If the process of leaving the EU is well managed, there need to be a big dislocation to confidence and demand. The UK has underperformed other big economies since the Brexit referendum in 2016 but not dramatically so. The employment rate, in particular, remains at record highs. The drip-drip of jobs being moved abroad, which recently came into focus with Nissan’s announcement that production of the next generation X-Trail would be shifted from the UK to Japan, will probably be a drag on UK economic performance in coming years, not an immediate shock.
The risk of a no-deal exit, on the other hand, could in our opinion be dramatic because of the immediate disruption to trade as well as what it says about the dire quality of policy making in the UK. The Bank of England’s reaction to the Brexit referendum result was exemplary. Faced with a national leap into the unknown, it restarted quantitative easing and made a quarter-point cut in interest rates as an insurance policy.
Aside from the Brexit risk, the bank’s monetary policy committee seems confident that growth and inflationary pressure are strong, particularly from the labour market, and that if should continue raising rates gradually. But as the US Federal Reserve correctly concluded, the threat to growth from a shaky world economy is real. Recent purchasing manager’s surveys for services, manufacturing and construction in the UK have been weak. That may simply be Brexit-related uncertainty or it may be more serious. Either way, there is a strong case for waiting until some of the political dust has cleared.
The Bank in our opinion is in a tricky position politically and economically. Having been accused by many Brexiters of over-egging the threats of a Leave vote, its forecasts now may turn out to be too optimistic. So be it. That is the nature of one – off events. As long as it is prepared to act rapidly and flexibly, the bank should be able to ensure it is one of the few policymaking bodies to emerge with its credibility intact from the mess that is the governance of Britain.