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Bank of England paints a bleak picture in event of a “Brexit”

Today’s Bank of England inflation report didn’t contain too much in the way of surprises in that the Bank downgraded its growth forecast for 2016 from 2.2% to 2%, while at the same time raising its inflation forecast.

The Bank also cut its growth forecast for Q2 from 0.5% to 0.3% in light of the recent slowdown in the latest economic data for April which saw all three PMI numbers come in significantly below expectations.

The bank also warned that “Brexit” could cause a sharp fall in the pound which in turn would trigger a sharp rise in inflation and in turn trigger a significant slowdown in growth.

As expected the warning was seized upon by Chancellor George Osborne as evidence of the risks a vote to leave would bring about, however the Bank wasn’t that much more optimistic about how the economy would perform in the event of a recovery in the aftermath of a vote to remain.

It would appear that the hyperbole employed by the “remain” campaign in order to secure a vote to stay in has damaged confidence in the UK economy and could well have longer term effects on the how the UK economy performs in the next couple of years.

This means that the Chancellor is even less likely to meet his rather ambitious deficit reduction targets by the end of the parliament, than he was six months ago.

The MPC went on to say that half of the recent slide in the pound was due to concerns about a “Brexit” and that a vote to leave the EU could also affect the outlook for GDP significantly, though what they base that assumption on, isn’t entirely clear.

For a baseline comparison for a similar sterling depreciation we could go back to when the pound dropped out of the ERM in 1992. The pound did slip back sharply, delivering a shock to the UK economy in the process, and this was a “Black Swan” event at the time as financial markets had little time to prepare.

Strangely enough despite the turmoil caused by sterling falling out of the ERM, economic growth didn’t slide back as the UK economy went on a growth spurt unprecedented in modern times, expanding at 0.7% in the aftermath of the turmoil in Q4 1992, and then expanding in every quarter until the financial crisis hit in 2008.

The Bank of England really needs to spell out in greater detail how it has arrived at its pessimistic forecasts today, which while credible do invite questions as to their methodology.

Would “Brexit” deliver an economic shock, undoubtedly it would, but the effects on the Euro and Europe would be no less considerable, as it wouldn’t be a zero sum game, so the currency effect could be mitigated.

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