Sunday, December 09, 2018
Be braced for more chaos, but give thanks to the Bank
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.

How do you like your uncertainty? Like bad luck, it comes in threes. There is the uncertainty of whether the prime minister can survive this week’s House of Commons vote on her EU withdrawal agreement, assuming it takes place, and what happens to the Brexit process if, as overwhelmingly expected, she loses.

There is the uncertainty of the prospect, which is greater than it was, of a Labour government under Jeremy Corbyn. Most people in business I speak to think Brexit will be a big enough disaster. Combine it with a Corbyn government, the only virtue of which might be that it would not be for ever, and you crank up the disaster dial to Titanic levels.

And then there is the risk of crashing out of the EU without a deal next March, the madness of which I discussed last week. In this you combine uncertainty effects with the real impact on supply chains for the most dangerous of cocktails.

There is, I should say, a glimmer of light on this. The advocate general’s recommendation to the European Court of Justice on Britain’s unilateral revoke article 50 unilaterally, together with one of Theresa May’s parliamentary defeats last week, on the Dominic Grieve amendment, has reduced the chances of a no-deal Brexit.

Malcom Barr of J P Morgan, who has been following the twists of turns of Brexit very closely, had put the probabilities as 20% for no-deal, 60% on an orderly exit along the lines proposed by the prime minister or something similar, and 20% for no Brexit. Now he puts the probabilities as just 10% for no deal, 50% orderly Brexit and 40% no Brexit. A no-deal Brexit could still happen, but the chances have fallen, which is good news, and it was this which helped sterling recover from its lows for the year against the dollar a few days ago.

How is the uncertainty playing out? The latest purchasing managers’ surveys, which are closely watched, suggested that the construction industry had a good November and manufacturing held up better than feared. But the alarm bells are ringing for the service sector, with its index dropping to its lowest level since July 2016, the immediate aftermath of the referendum, with Brexit mainly to blame.

As Chris Williamson, chief economist at IHS Markit, which produces the surveys, put it: “The surveys are so far consistent with 0.1% GDP [gross domestic product] growth in the fourth quarter, thanks to the expansion seen back in October, but growth momentum has since been lost and risks are clearly tilted to the downside.” Instead of striding confidently into departure from the EU, Britain will be getting there on hands and knees.

It is in this context that the Bank of England has been coming in for some undeserved flak, including from the previous governor Lord (Mervyn) King. While the reputations of many institutions have deteriorated in recent years, including parliament, the Bank’s I would say has been enhanced. Mark Carney, now more than five years into the role as governor, made it his job to reorganise and professionalise the Bank.

And, while some of us have had run-ins with him, few can doubt his attention to detail. The Bank did not want to publish its internal work on Brexit scenarios but did so in response to a request from the Commons Treasury committee. Not to have published the scariest stress-test scenarios in response to that request would have been dishonest.

Nor was this, as the American economist and New York Times columnist Paul Krugman has argued, a product of “black box” modelling. The Bank has done the work, involving 20 senior economists and the expertise of 150 other professionals over two years.

And, as Krugman also pointed out: “It’s truly amazing that Britain finds itself in this position. If the downsides are anywhere close to what the BoE asserts, given the risk — which we’ve known for a long time was substantial — of a hard Brexit, it was an act of utter folly not to have put in backup capacity at the borders.”

The Bank has dug into the detail, as anybody watching Carney’s tutorial on how the port of Dover works. given to the MP for Dover, can testify. As he pointed out, you cannot easily shift freight from a roro (roll on, roil off) port like Dover to a lolo (lift on, lift off) port like Southampton without a big investment in new port infrastructure, for which it is too late.

The Bank’s worst-case scenarios on Brexit were also in part informed by its own survey evidence. The Bank’s regional agents, together with its decision-maker panel survey, asked businesses about their state of readiness for a no-deal Brexit (just under a third had made some changes) and about the impact on output over the next 12 months in the event of an exit without a deal. The expected fall in output ranged from 2.5% to 6.9%, compared with a rise of between 0.8% and 2.7% under deal and transition. The difference between the two, which is what matters, reaches a maximum of 9.6%, almost 10%.

The Bank, as I say, has done the work, whereas its critics have not. Is it institutionally anti-Brexit> The Bank’s mission statement is that its purpose is “promoting the good of the people of the United Kingdom by maintaining monetary and financial stability”. Anything that threatens that stability, as a no-deal Brexit would so, will clearly not meet with its approval.

But if the Bank was “remainer central” as some accuse it of being, in common with the Treasury, it would presumably favour what many remain supporters regard as the next best thing to staying in the EU, the Norway option of remainingin the single market via membership of the European Economic Area (EEA).

The Bank has however made it crystal clear that such an outcome would be a threat to Britain’s financial stability. As Sir Jon Cunliffe, a deputy governor, told the Treasury committee: “Our financial sector is about 20 times bigger than Norway’s. It is much more connected internationally and more complex … That scenario of being a complete rule-taker for a financial sector this large and complicated would be … quite uncomfortable.” Carney added that “the risk of being a rule-taker goes up with time” and “from a financial stability perspective, it is highly undesirable to be a rule-taker and to lose supervisory autonomy for any considerable length of time”.

It is possible that the Norway option could be modified to allow a significant UK input on the rules affecting financial services. To come close to satisfying the Bank it would have to be.

The other reason for being thankful for the Bank is its conduct since the referendum. In the political vacuum that followed the vote to leave on June 23 2016, it was Carney who stepped into the breach to offer reassurance. This was followed by a calming series of measures from the Bank, including a cut in interest rates, more quantitative easing and a term funding scheme to keep money flowing into the economy from the banks.

Since then, while the government has spent all its time coming up with an agreement that nobody much likes, the Bank has got on with the job of ensuring that the financial sector for an eventuality, including those in its worst-case scenarios.

If we did succumb to the madness of no-deal, meanwhile, the Bank would respond. Its financial policy committee saying last week that by lowering the banks’ so-called countercyclical buffer rate, it could enable to banks to absorb losses of up to £11bn and provide £250bn of lending capacity to households and businesses. The Bank has warned of the adverse impact of a disruptive no-deal, but it would first on hand to attempt to mitigate its effects.