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The UK economy is slowing— and it's not just because of the 'Brexit' vote

The Bank of England cut its growth outlook for the U.K. from 2016 through to 2018 on Thursday, as it announced no change to its main interest rate and stock of purchased assets.

Members of the Monetary Policy Committee (MPC) voted unanimously to keep the main rate at the record-low of 0.5 percent and maintain the bank's stock of purchased assets at £375 billion ($543.4 billion). The follows the MPC's meeting this week and came as no surprise after seven years of holding rates.

"In the United Kingdom, activity slowed in the first quarter and a further deceleration is expected in the second quarter. There are increasing signs that uncertainty associated with the EU referendum has begun to weigh on activity … In the Committee's latest projections, activity growth recovers later in the year, but to rates that are a little below their historical average," the bank's summary of the MPC meeting said.

Guests wearing pro-Brexit t-shirts arrive for the premiere of "Brexit: The Movie" in London.
Bloomberg
Guests wearing pro-Brexit t-shirts arrive for the premiere of "Brexit: The Movie" in London.

U.K. gross domestic product (GDP) growth is now seen averaging 2.0 percent in 2016, down from the 2.2 percent forecast by the bank in February. Growth is seen at 2.3 percent in both 2017 and 2018, down from the 2.4 percent and 2.5 percent annual rates forecast in February.

The bank said U.K. economic activity growth would pick up by mid-2017 in the event of a "remain" vote, but would be weaker than forecast in February. It attributed this to disappointing productivity growth, fiscal consolidation and relatively high debt-to-income ratios that suggested households would be less likely to cut back on saving and spend more than assumed previously.

"The biggest risk to the forecast remains the referendum," Bank of England Governor Mark Carney said at a media conference on Thursday.

"If there were a vote to leave ... we would expect a material slowdown in growth and a notable rise inflation — a challenging trade-off," he later said.

Recession risk

Carney added that in a downside a scenario, a "Brexit" could result in a technical recession — a risk several economists have touted in recent weeks.

U.K. GDP growth slowed to 0.4 percent in the first three months of the year, down from 0.6 percent in the fourth quarter of 2015. The bank sees growth slowing further between April and June this year, to 0.3 percent.

The U.K. Treasury estimated in April that Britain would be worse off by £4,300 per household per year after 15 years outside the European Union (EU).

Carney said a Brexit would likely result in a higher risk premium on sterling assets and a decline in foreign direct investment (FDI).

"It would appear that some of the considerations behind FDI is the U.K.'s status vis-a-vis the rest of Europe," he said at the conference.

Sterling fall partly due to referendum

Sterling has declined by around 9 percent since in a peak in November 2015. The bank said in its inflation report on Thursday that roughly half of that decline reflected the perceived risks of the Brexit vote.

Carney said the currency could suffer a further sharp fall if the country quit the EU.

In its report, the bank added that the cost of insuring against a depreciation in sterling, versus an appreciation, had increased substantially, suggesting market participants saw a further steep decline in the U.K. pound as relatively likely following the referendum.

The impact on other U.K. assets, such as equities, was harder to quantify, the central bank said.

Carney added that it was a fair assumption that international financial markets would suffer negative spillovers from a Brexit. He said this was the no. 1 issue raised when he met with fellow central bank governors, foreign ministers and heads of major international corporations, banks and asset management firms, as well as domestic small-and-medium-sized enterprises.


Further easing?

The fallout from a Brexit vote could be such that the bank introduces new monetary easing measures. These could include quantitative easing, credit easing or additional liquidity facilities for banks, Carney said on Thursday.

He added that the Brexit referendum posed a more serious economic risk than 2014's Scottish independence vote.

"The issues around Scotland principally affected financial stability in the short-term … these were issues that we took seriously … but they were not issues that at the time, in the judgement of the MPC, rose to the level of being the biggest risk to the economic outlook to the U.K.," Carney said.

He denied the bank was breaching its political independence by setting out the risks of leaving the EU.

"We are providing information as best we can about a potential reaction scenario ... it gives a sense of the major risk," Carney said.

Rates seen lower for longer

The Bank of England held its forecast for consumer inflation at 0.4 percent for the second quarter of 2016 — far below the targeted 2.0 percent.

"This shortfall is due predominately to unusually large drags from energy and food prices, which are expected to fade over the next year," the bank said in its summary of the MPC meeting.

It cut its forecast for the second quarter of 2017 to 1.5 percent from 1.6 percent and held its estimate for second quarter 2018 at 2.1 percent. Inflation is seen at 2.2 percent in the second quarter of 2019.

The bank now sees its base rate remaining at 0.5 percent until the second quarter of 2017 at the earliest, having previously forecast the rate would reach 0.6 percent by then. It also cut its predicted rate for the second quarter of 2018 to 0.6 percent from 0.9 percent.

External forecasters are more bullish, forecasting the main rate will reach 0.8 percent by the second quarter of 2017 and 1.3 percent by the same period in 2018, according to the Bank of England.

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