Carney’s warning of a Brexit recession sparks war of words between Threadneedle Street and former Chancellor
The Bank of England has warned that leaving the European Union could trigger a recession, lead to a jump in inflation, higher unemployment and a “sharp” depreciation in the value of sterling.
Threadneedle Street issued its most hard-hitting analysis of the likely effect of Brexit in the final Super Thursday before the referendum on 23 June, as the monetary policy committee (MPC) voted unanimously to maintain interest rates at 0.5 per cent for another month.
The intervention triggered an unprecedented attack by former chancellor of the exchequer, Lord Lamont, who questioned Carney's judgement in wading in to the debate, warning he could be responsible for triggering an economic crisis.
The Brexit effect
“A vote to leave the EU could have material economic effects,” governor Mark Carney said in his obligatory letter to the chancellor explaining why inflation remains below the Bank’s official two per cent target.
The quarterly Inflation Report added: “Households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise. Asset prices might fall, leading to tighter financial conditions.
Read more: The OECD's Brexit warning
“Companies could postpone some investment projects or recruitment plans until the outlook becomes clearer. Households too might defer some spending, particularly on major purchases.
“Were the United Kingdom to vote to leave the European Union, it is like that sterling would depreciate further, perhaps sharply,” the Bank concluded in analysis that puts the Old Lady at the centre of the debate over the claims and counterclaims being thrown about in the referendum campaign and will provoke accusations of scaremongering.
Lord Lamont, chancellor under John Major and now a member of the official Vote Leave campaign organisation, said Carney should "be more careful that he doesn't cause a crisis" arguing that his "unwise words [could] become self-fulfilling."
Vote Leave disputed the Bank's claims saying that "the evidence for effects of the referendum on the real economy are limited".
Growth cut
The Bank did not put a precise figure on how much it expects unemployment to rise or the pound to fall in the event of Brexit. It did calculate that uncertainty related to the vote “accounted for roughly half of the depreciation in sterling”, which has already been seen – approximately nine per cent.
Vote Leave questioned this analysis as it pointed out the pound had actually strengthened over the last month, as we approach the referendum date.
The Bank also trimmed its forecasts for economic growth. It now expects the UK economy to expand by two per cent this year – down from its prediction of 2.2 per cent in February. The economy will then expand by 2.3 per cent in 2017 and 2018, down from predictions of 2.4 and 2.5 per cent respectively.
Key figures from the Bank of England's Inflation Report
| 2016 | 2017 | 2018 | |
| GDP growth | 2.2 per cent | 2.3 per cent | 2.3 per cent |
| CPI inflation | 0.4 per cent | 1.5 per cent | 2.1 per cent |
| Unemployment rate | 5.1 per cent | 5.0 per cent | 4.9 per cent |
Although the Bank still predicts inflation will surpass its two per cent target by the middle of 2018, it noted that markets had not fully priced in the first rate rise until the second quarter of 2019.
Analysts said that the Bank’s forecasts were likely to be inherently unreliable given the difficulties of assessing how the economy would react after the referendum – whichever way the UK votes.
In its calculations, the Bank stripped out the exchange rate volatility caused by the referendum to try and account for this, but cautioned that it was unable to isolate the effect of the vote on other asset prices, which would be affected.
While the Bank has observed a spike in uncertainty – calculated through various measures of business and consumer confidence surveys – it said this would quickly dissipate after the vote, assuming the UK remains in the European Union.
Read more: The MPC is a master of inaction
Although the effect of this uncertainty on growth would be neutral over the medium-term, growth, would not bounce back as quickly, as higher levels of confidence take time to feed back into investment and spending decisions.
Post-Brexit trade deals
Mark Carney also waded in to the political fallout of Brexit and the wrangling between the campaigners over how quickly the UK could secure some kind of trading arrangement with the rest of the EU.
In the event of a vote to leave the European Union, the period of uncertainty could be prolonged, as the UK’s future trading arrangements with other countries would take some time to renegotiate.
During that period, the ultimate nature and extent of those relationships and their impact on UK potential growth and incomes would not be entirely clear.
– Bank of England’s May Inflation Report
Pen pals
Unsurprisingly, George Osborne welcomed the governor’s Brexit warnings. He said that Carney had outlined the “lose-lose situation that a vote to leave the EU creates”.
The MPC noted that the vote to leave could force them into a difficult trade-off between “stabilising inflation on the one hand and stabilising output and employment on the other.”
Big moment in EU debate: Bank of England warns vote to Leave would mean both materially lower growth and higher inflation. It's a lose-lose
— George Osborne (@George_Osborne) May 12, 2016
The chancellor said: “One choice would impose costs on families as higher inflation reduced real household incomes; the other choice would impose costs on families with a hit to the economy and jobs.”
The co-ordinated response from Osborne and Carney, which came in the form of the letters the governor and chancellor must exchange every month inflation is below one per cent or above three per cent, will no doubt irk Leave campaigners.
He was also criticised by the think tank Open Europe for going “too far” when he said a vote to leave could also trigger a balance of payments crisis.