Sunday, July 03, 2016
Carney in a battle to head off a post-Brexit recession
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

What an extraordinary time it has been. During the worst of the global financial crisis I wrote that we had 10 years of big economic and financial stories crammed into about 10 weeks. Something similar has been happening in the past few days.

Even leaving aside what is going on at the top of British politics, which is completely barking, this is an action-packed time. Remember all that agonising about whether Britain’s AAA sovereign debt rating would be downgraded? On Monday, the last remaining AAA rating, from S & P, vanished with a big downgrade and Fitch, another agency, also took us down another notch.

Sterling has tumbled but not yet collapsed, though has hit a 31-year low, while the stock market has almost been a caricature of itself; despair followed by euphoria. I would like to take some reassurance from the euphoria bit though, thinking back to the crisis, I recall that the FTSE-100 was still surprisingly buoyant in the late spring of 2008 and gave little sign of the horrors to come.

Meanwhile, as if on cue, official figures reminded us of one of Britain’s important sources of vulnerability. The current account deficit in the first quarter – the red ink on the balance of payments - was a worryingly large 6.9% of gross domestic product, only marginally down on the record 7.2% of the final quarter of 2015.

So what is going to happen? We are still in a state of limbo in terms of the economic impact, short and long-term, of the referendum decision. There is some preliminary evidence that consumer confidence has taken a hit and a lot of talk of cancelled investment projects but very little hard evidence.

That will be the case for some time. Even the June purchasing managers’ surveys, normally a good indicator of what is currently happening, are based mainly on data collected before June 23. For most surveys, and even more so for the official statistics, we may have to wait until August for hard evidence, and that will only be for the initial impact.

In the absence of that, however, economists have been busy adjusting their forecasts downwards. A sample assembled by Consensus Economics gives an idea. Before the referendum the expectation was for 1.9% growth this year, 2.1% next. Now the numbers are 1.4% and 0.4% respectively. That does not sound too bad, but it implies a technical recession – two or more quarters of declining gross domestic product – between now and next summer.

And, if the consensus is right then, for those nostalgic for one of the high spots of the referendum campaign, it implies that GDP per household will be about £1,450 lower by the end of next year than it otherwise would have been.

Some are even gloomier. The Economist Intelligence Unit, which topped my annual forecasting league table in 2012, predicts an outright recession, with the economy shrinking by 1% next year on the back of a big fall in investment and weaker growth in consumer spending. GDP by the end of next year will be 4% lower than it otherwise would have been. Unemployment will rise, it says, and the budget deficit go back up to 5.5% of GDP (from about 4%) and public sector debt rise to 100% of GDP in coming years, from 84% now.

Why should we go into recession? Business investment, which was falling earlier this year on pre-referendum uncertainty, seems likely to be very weak for some time to come. Consumers, apart from feeling unsure, will be hit by the rising prices that result from sterling’s fall.

And, if you really want to be depressed, listen to the respected John Llewellyn, former OECD chief economist, and his team at Llewellyn Consulting. In a note to clients the firm said: “We are more worried - for the UK, though importantly not for the world - than we were in 2008 or any other post-WWII crisis. And between us we have been present for every one of them. The scale of all this will start to unfold in coming weeks.”

The challenge for the authorities is to turn this gloom around. And, in the state of political limbo in which we find ourselves, that for the moment means the Bank of England. On Thursday I, along with other journalists and a large invited audience from the City, assembled in the Court Room of the Bank of England to hear Mark Carney. There was a frisson when, talking about jobs, the governor asked: “Will I keep mine?” He was putting into words the concerns ordinary people have when times are uncertain but he also faced questions about whether he would survive in a post-Brexit government. My view is that the worst thing you could do for confidence is get rid of the Bank governor, but anything is possible amid the current madness.

Carney, as you will have read, had one important message. The Bank’s monetary policy committee (MPC) had been expecting to raise interest rates over the next 2-3 years. Now it is likely to cut them, even from the record low of 0.5%, starting on July 14. Before August is out interest rates could be zero, and another round of quantitative easing (QE) is a possibility. I do not see negative interest rates but other policy tweaks are possible, including so-called credit easing, with the Bank buying assets other than gilts, and action on the Funding for Lending scheme.

Such moves will help ease the shock to the economy but we should not overstate their potency. A cut in rates from 0.5% to zero does not take us very far. QE may be of limited use when long-term interest rates are already very low. Carney himself made the point that there are limits to what monetary policy can do, and that – even when it is effective – its impact is not immediate.

The best the Bank can do may be to reassure. When Mario Draghi, the president of the European Central Bank, promised to do “whatever it takes” to hold the eurozone together, it helped do so. Carney’s “all the necessary steps” message is in a similar vein. The Bank, like the rest of us, has to hope it helps stop some of the nastier outcomes now predicted by economists from becoming a reality.