Post EU referendum, Government intervention is needed to steer the economy through choppy watersby George Magnus / August 4, 2016 / Leave a comment
Project Fear has come alive with the Bank of England announcing a drastic revision of its previous economic assessment of the economy, and announcing a robust set of measures designed to mitigate the effects of what it sees as the drag in the post-EU referendum economy—including cutting interest rates from 0.5 per cent to 0.25 per cent. We should welcome the Bank’s attempts to administer some painkillers to the UK economy, while also noting that the Bank alone is not equipped to undo the damage Brexit will do to the economy and to living standards.
Bank’s eye view
First, consider the Bank’s broad economic view. The economic outlook for 2016 is pretty much baked in the cake thanks to a fairly decent first half of the year. The initial second quarter GDP data have the economy 2.2 per cent stronger than a year ago. It is exceptional—I couldn’t find an instance—for the Bank to cut interest rates when the last known GDP data were above 2 per cent. But the Bank expects stagnation in the second half of 2016, and has slashed the 2017 growth forecast from 2.3 per cent to 0.8 per cent, and the 2018 outlook from 2.3 per cent to 1.8 per cent. It is not predicting a recession, per se, but it seems reasonable to expect a quarter or two of economic contraction starting very soon.
The Bank thinks unemployment will now rise to 5.6 per cent by 2018, though this could be an under-estimate if demand turns out weaker than the Bank is forecasting. It says that inflation will now be twice as high in 2016 at 0.8 per cent, close to 2 per cent in 2017, and 2.4 per cent in 2018. Remember, if there is no parallel bounce in wages and salaries, most people will become worse off as a consequence because their real incomes will be reduced. While the Bank has a formal mandate to keep inflation at 2 per cent, it is also has a duty to maintain economic stability and to prevent circumstances arising in which deflation would return. The exchange rate is the main factor driving up inflation, and the Bank is happy to see through this and divert its attention elsewhere.