As next month’s deadline approaches for the UK to start its formal withdrawal from the EU, polling tends to show that not many voters are feeling “Bregret” for having backed Leave in last year’s referendum. No doubt the solid performance of the UK economy has encouraged that confidence.
Defying widespread predictions of a shock from a Leave vote, the economy has continued to grow steadily. Official data released on Wednesday only slightly spoilt the Brexiters’ talking point that the UK was the fastest-growing of the world’s large economies last year. A downward revision put growth for the whole of 2016 at 1.8 per cent, fractionally below the 1.9 per cent annual growth recorded by Germany.
Still, there are some straws in the wind that suggest the threat of a Brexit shock may have been postponed rather than cancelled. Certainly, although the Bank of England revised up its forecasts for UK growth earlier this month, it should plan to keep interest rates on hold until presented with definitive evidence that domestic inflationary pressure is rising.
In particular, two consecutive months of falling retail sales have cast some doubt on the optimistic scenario. The drop should not be entirely surprising. The one obvious adverse reaction to the referendum result was a sharp fall in the value of sterling. Unless that depreciation was to be entirely absorbed in margins, some would inevitably be passed on in the form of higher consumer prices, eating into real earnings and reducing disposable income.
Nor are there any signs that employees are seeking to claw back that lost income with wage increases. Wage settlements show a deceleration in pay bills. Unemployment might have fallen to its lowest in more than a decade, but there are precious few signs that the labour market is tight enough to generate substantial nominal earnings growth.
The other area of concern is business investment, which fell in the fourth quarter of 2016. The Institute of Directors reports that about a fifth of its member companies are reining in expansion plans in the UK since the referendum — decreasing investment, delaying hiring employees or indeed considering moving operations abroad.
By themselves, these do not add up to anything like conclusive evidence that the economy is running out of steam. But they do justify the Bank of England — unlike, for example, the US Federal Reserve — keeping interest rates on hold in the medium term, even if the sterling shock pushes up import prices.
The last time there was a big fall in the pound, after the global financial crisis hit in 2008, the BoE’s Monetary Policy Committee (MPC) rightly allowed the rise in the price level to work its way through, temporarily raising inflation which then subsided. True, there have been several years of solid growth since then, and there is probably less spare capacity in the economy. But without any real sign that a wage-price spiral is being established, the same watch-and-wait attitude is justified on this occasion.
If the period since the referendum result has been something of a political phoney war, the real conflict could be about to begin in earnest. If exit talks between the UK and the rest of the EU turn sour, confidence in medium-term prospects for the British economy could also weaken, and more hiring and investment decisions put on hold.
The Bank of England was right to respond to the potential shock of the referendum result by loosening monetary policy last summer. It would be equally wise to err heavily on the side of keeping it on hold now.
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