Bank of England Cancels Brexit Downturn, Economists Disagree Though

The Bank of England has effectively written out any negative impacts to the UK economy pertaining to Brexit in their latest forecasts.

The Bank’s February Inflation Report contains forecast for the UK economy to grow at 2% in 2017, up from 1.4% forecast back in November and the meagre 0.8% forecast in August.

“The Brexit-defying UK economy will expand by 2% this year, no more sharp slowdown to growth from Brexit.” says Neil Wilson at ETX Capital. “The UK remains the fastest growing G7 economy – not bad for a nation that some think has committed an act of self-mutilation in choosing the leave the EU.”

However, the Pound fell despite the upgrade to growth the market sees the report as offering no indication that the Bank is leaning towards raising interest rates.

Indeed, inflation forecasts remain steady.

Inflation is likely to overshoot the 2% mark but the Bank is happy to overlook this for a while.

“Although it says the next move on rates could be in either direction, there appears to be significant hurdles to the Bank hiking interest rates any time soon,” says Wilson.

Of note is the comment around monetary policy not being enough to combat the real adjustment required for new trading arrangements.

The bank noted that, “attempting to offset fully the effect of weaker sterling on inflation would be achievable only at the cost of higher unemployment and, in all likelihood, even weaker income growth”.

“This looks like a major barrier to rates being hiked,” says Wilson. “A touch of humble pie for the Bank, as it’s been made abundantly clear that the economic Armageddon it expected in the event of Brexit has just not materialised.”

Downside Risks

The Bank does however maintain that downside risks to growth remain.

The UK is likely to leave the EU with no guarantees on trade – WTO tariffs might be the best the country gets.

“No one should doubt the importance of what this means, particularly regards the Sterling exchange rate,” says Wilson.

The Bank also flagged the very real danger of rising prices and stalled pay growth to have a significant impact on consumer spending – which is important as it’s been a consumer-led bounce since the EU referendum.

Analysts: BoE Forecasts too Optimistic

The Bank has raised forecasts for the economy largely on the back of the resillience shown by the UK consumer which they reflect on as having pretty much ignored the Brexit vote.

Since the referendum, the UK economy has exceeded expectations, mainly on the back of a resilient consumer sector.

Despite a slowdown in real income growth, consumers have continued to spend by borrowing more, consequently leading to a fall in the savings ratio.

After an initial dip in sentiment, business activity rebounded, shielded by the resilience of consumer demand, weaker sterling and because the exact impact of the vote to leave on businesses is unclear both in terms of magnitude and timing.

Therefore, the outlook for 2017 growth will depend critically on consumer demand.

Analysts at Credit Suisse believe real disposable incomes are likely to grow slower and even fall, as the drop in Sterling passes through and pushes up inflation.

"Consumers can now either continue to borrow more, causing a further fall in their savings ratio, or to reduce their consumption. In December, we saw the first signs of a slowdown of consumer spending with a fall in retail sales and the key question is whether this will be sustained," says Research Analyst Honglin Jiang at Credit Suisse in London.

Credit Suisse forecast consumer spending growth to fall from 2.8% in 2016 to 0.7% in 2017.

They expect growth to slow down from 2.0%y/y in 2016 to 1.2%y/y in 2017.

However, as is the case with the economists at the Bank of England, Credit Suisse concede uncertainty around our UK forecasts remains high.

"The biggest risk to our call is that the first signs of a slowdown in consumer spending seen in December are not sustained and the consumer sector is resilient, fuelled by higher borrowing," says Jiang.

Daniel Vernazza, economist with UniCredit in London, is another one of those who believes UK economic growth is to slow this year, although the exact timing and extent of a slowdown remains highly uncertain.

"The stronger than expected growth since the Brexit vote has been entirely due to much stronger than expected household consumption growth. It won’t last," says Vernazza.

The analyst says consumption growth will slow as a result of higher imported inflation and the impending squeeze on real household income growth.

The BoE reckons the savings rate will continue to fall from an already very low level and for Vernazza this looks particularly risky given high uncertainty both domestically (surrounding Brexit) and globally.

Moreover, the BoE’s judgement on the savings rate seems to be supported by their projection that the unemployment rate will fall further, from the current 4.8%, which in Vernazza's view is unlikely as economic uncertainty is likely to hit hiring.

UniCredit forecast real GDP growth of 0.3% qoq in 1Q17 and annual growth of 1.4% in 2017.