By Andy Bruce and David Milliken
LONDON (Reuters) – The Bank of England said on Thursday that Britain should enjoy solid economic growth if the government achieves a smooth departure from the European Union, potentially paving the way for a first interest rate increase since 2007.
But a month before a national election, BoE Governor Mark Carney warned that this year would be challenging for British households as they become increasingly strained by higher inflation driven by last June’s Brexit vote.
Despite weak industrial output data on Thursday that underlined a sharp economic slowdown at the start of this year, the Bank said Britain’s economy should be able to expand in coming years at a pace similar to 2016’s robust performance.
But this forecast hinged on a “smooth” transition to Brexit, as well as a big pick-up in wage growth — something the central bank has struggled to forecast in recent years.
Carney said the BoE had not made forecasts based on the scenario of a “disorderly Brexit” where Britain crashes out of the EU without an agreement on future relations.
While the economy as a whole was forecast to hold up in the short run on the back of stronger exports and investment, the Bank’s latest quarterly forecasts showed a sharper squeeze on consumer spending this year than it previously expected.
“This is going to be a more challenging time for British households,” Carney told a news conference. “Real income growth … will be negative (and) wages won’t keep up with prices.” He said inflation would near 3 percent this year.
But Carney said it was important to put this into the context of an economy that was still growing and which employed a record number of people.
Official data showed economic growth slowed to just 0.3 percent in the first quarter of 2017, less than half its rate at the end of 2016.
Many economists expect tougher times ahead than the Bank of England does, as Prime Minister Theresa May starts two years of fraught Brexit talks before the country leaves the European Union at the end of March 2019.
The Bank said on Thursday they could only do so much to offset the Brexit hit to the economy.
“Monetary policy cannot prevent either the necessary real adjustment as the United Kingdom moves towards its new international trading arrangements or the weaker real income growth that is likely to accompany that,” the policymakers said in a summary of this week’s rate-setting meeting.
The central bank also indicated that interest rates may need to start to go up within the next couple of years, possibly around the time Britain leaves the EU in 2019.
“Monetary policy could need to be tightened by a somewhat greater extent over the forecast period than the very gently rising path implied by the market yield curve underlying the May projections,” the Bank said on Thursday.
Sterling slipped after the Bank’s announcement which some investors had expected to show a deepening split among policymakers about the need for higher interest rates now, something that did not materialise.
“The Monetary Policy Committee remained in wait-and-see mode this month,” the Confederation of British Industry’s chief economist, Rain Newton-Smith, said.
“Any changes to monetary policy are unlikely in the near future, particularly amid ongoing uncertainty over the impact and outcomes of EU negotiations,” she added.
BOE ASSUMES SMOOTH BREXIT
The financial market instruments which the Bank uses to construct its economic forecasts had fully priced in an interest rate rise only in the final three months of 2019, nine months later than in the last set of forecasts in February.
But these market assumptions were based on average prices in the two weeks to May 3. Since then, markets have moved to price an earlier rate hike by the BoE and sterling has strengthened, which should help to push down on inflation.
The BoE’s Monetary Policy Committee (MPC) voted 7-1 in favour of keeping rates on hold at their record low 0.25 percent this month, as expected in a Reuters poll.
American academic Kristin Forbes, who leaves the MPC at the end of June, again voted to raise rates to 0.5 percent. Echoing language from the last policy meeting in March, the Bank said it would not take much upside news on growth and inflation for some other members of the MPC to join Forbes.
The central bank trimmed its forecast of growth this year to 1.9 percent from 2.0 percent, but nudged up its forecasts for 2018 and 2019 to 1.7 percent and 1.8 percent. Last year Britain’s economy grew 1.8 percent.
The Bank said inflation was likely to fall back to 2.16 percent in just over two years’ time – still above the BoE’s target – and then pick up slightly going into 2020. Usually BoE inflation forecasts show inflation falling back to target.
Wage growth – which has been weak in Britain since the financial crisis – is forecast to pick up to 3.5 percent next year from around 2 percent at present as businesses find it harder to recruit staff.
Carney said one-off factors had been hurt wage growth, and the economy had shown unexpected capacity to create jobs, when asked why previous similar BoE forecasts has failed to materialise.