Would the Bank of England really increase borrowing costs even as the UK faces the prospect of a recession? Or is today’s warning yet more “project fear” from Threadneedle Street?
Let’s start with the facts: yes, one can technically envisage a theoretical scenario where the UK has a chaotic no-deal Brexit, where sterling fell sharply, tariffs were imposed and suddenly prices across the economy rose.
It is possible to imagine the Bank of England taking a hard line, looking at its inflation target (CPI is already above the 2% mark) and declaring that based on its remit the reasonable thing would be to leave rates unchanged or even to lift them.
And then there’s the real world.
It seems frankly implausible that the UK could face a recession and that the Bank would decide to exacerbate the financial pain by lifting borrowing costs. It just doesn’t happen.
Even in the early 1990s, when interest rates were in double digits (for a different reason – it wasn’t inflation being targeted but exchange rates), as soon as it became clear that the UK was facing a recession interest rates were cut rather than being raised.
Indeed, consider what happened two years ago. The then-chancellor and the Bank warned before the referendum that interest rates might rise if the UK voted leave. Most economists and commentators, myself included, said that this seemed deeply implausible.
Lo and behold, at the first practicable moment after the referendum the Bank cut interest rates. It even pumped an extra few tens of billions of pounds into the economy through quantitative easing.
In short, it did precisely the opposite of what it warned about before the referendum. It is hard to conclude that the same working assumptions shouldn’t apply this time around as well.
It is certainly true, as the Bank points out in its inflation report today, that “there is little monetary policy can do to offset supply shocks”.
Cutting interest rates will not improve the UK’s underlying economic performance as it adapts to a new trading relationship.
But rate cuts are the traditional remedy to demand shocks in the economy. And that – a demand shock – is precisely what most economists think would happen if the UK crashed out of the EU.
In short, of course nothing is impossible, but I would be amazed if the Bank responded to a no deal by raising borrowing rates.
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