Bank of England downgrades growth forecast as Brexit hits sentiment

• The Bank of England cuts 2019 and 2020 GDP growth forecasts amid Brexit uncertainty
• Large downgrade to business investment forecast
• If an orderly Brexit is achieved, Schroders still expects rates to rise later this year

In its latest quarterly Inflation Report, the Bank of England (BoE) has downgraded its outlook for UK real GDP growth to a pace not seen since just before the Global Financial Crisis. The Bank has blamed slower activity abroad, but most of the downgrade is caused by the effects of the heightened level of uncertainty related to Brexit.  

The forecast for annual average GDP growth has been lowered from 1.7% to 1.2% for 2019, and from 1.7% to 1.5% in 2020. However, the forecast for 2021 was nudged higher from 1.7% to 1.9%. Within these figures, the contribution to growth in 2019 from net trade was lowered as growth in exports was downgraded, while growth in imports (negative for GDP) was revised higher in the forecast.

Meanwhile, business investment was previously expected to grow by 2% in 2019, but the forecast has now been slashed to show a fall of 2.75%. BoE Governor Mark Carney explained that the weaker outlook for business investment is related to Brexit uncertainty, as firms delay investment projects in anticipation of greater clarity.

Part of the BoE’s decision to downgrade the forecast is the possibility that Brexit uncertainty may not be resolved by the end of March. However, if the “smooth” Brexit is achieved with a transition period, then there is substantial upside risk to the growth and inflation forecast.

Otherwise, Carney stated that the fundamentals of the economy are sound. The labour market continues to perform well, as wage growth has overtaken inflation, helping to boost the disposable income of households.

Overall, the optics of the latest Inflation Report would suggest that the BoE is slowly changing its mind about raising interest rates any further. However, upon closer inspection of the details, much of the forecast downgrade is attributed to what the Bank expects will be short-term factors. This includes temporary weakness in Europe as much as the current Brexit uncertainty. While the BoE highlights that there is a one in four chance of a recession in the near-term, and that those odds would rise in a “no-deal” Brexit scenario, the odds would also fall if an orderly Brexit is achieved.

As a result, we re-affirm our forecast that, assuming an orderly Brexit, the Bank will raise its main policy interest rates at the first opportunity, but would do so during an Inflation Report meeting. This may not happen in time for the next such meeting in May if Brexit is delayed slightly, but a rise by August seems likely. Of course, in the event of a “no-deal” Brexit, then in line with our forecast of a recession, we would look for the Bank to cut interest rates to support growth.