Prior to the EU referendum on 23rd June the Treasury published “the immediate economic impact of leaving the EU”, which warned of dramatic short-term consequences arising from a Brexit. It predicted that government borrowing costs would rise, economic activity would fall and a recession would become a near certainty.
However, analysis published by the Bank of England yesterday appears to contradict these alarmist predictions. The majority of UK firms are seeking to maintain ‘business as usual’, leading the Bank to conclude that “there is no clear evidence of a sharp general slowing in activity”. There is also little sign of employment being affected by Brexit, with the recruitment firm Reed claiming that 150,000 more jobs have been added to its site since the referendum compared to the same period last year. And, of course, the Treasury’s claim that ten year government bond yields would increase by 40 to 100 basis points was completely incorrect. In reality, the reverse has actually happened. A couple of weeks ago, the UK held its first government bond sale since voting to leave the EU, issuing £2.5bn of debt that attracted robust demand from global investors. Ten-year gilts, which started the year trading at interest rates of 1.96 per cent, fell to just 0.78 per cent.
Of course, there is a degree of uncertainty arising from Brexit and there has certainly been significant volatility in the currency exchange market. But apocalyptic predictions by the Treasury have not emerged, raising major questions about whether Brexit would be responsible for any possible recession in the near future.
The ‘business as usual’ outlook for UK economic activity also undermines the argument for a further loosening of monetary policy. Furthermore, data released this week shows that inflation has increased to 0.5% and core inflation is now at 1.4%, which is approaching the Bank’s inflation target. We should also expect further inflationary pressures from the fall in Sterling’s value given the impact on the cost of imports. It is obvious that reducing rates or increasing the Asset Purchase Programme (APP) would only increase the risk of the Bank overshooting its inflation target in the coming years.
It is very welcome that the Bank took no action on bank rates and the size of the Asset Purchase Programme in July, but it is concerning that most Monetary Policy Committee members expect monetary policy easing next month. The Bank must avoid falling into this trap, which could further exacerbate problems associated with the UK’s policy of ultra-loose monetary policy over the past seven years. Its own analysis has concluded that there is no evidence of a slowing in economic activity. There's no reason, for now, to pursue looser monetary policy.