Belfast Telegraph

'Risks on either side' for forecast of how economy will react to Brexit

Current levels of consumer confidence cannot last amid market pessimism and cautious business investment in the wake of the Brexit vote, a key Bank of England rate setter has said.

Reaction to the EU referendum has differed across the economy, but not all of those assessments can be correct, external Monetary Policy Committee (MPC) member Gertjan Vlieghe has said.

Financial markets seem to expect UK economy will fail to deliver, as signalled by a the collapse of the pound and falling share prices of domestically-focused UK firms, Mr Vlieghe said during a speech at Sheffield University.

Those shares have underperformed the US stock market by 11% and the European stock market by 7%.

Meanwhile, UK business sentiment seems "somewhat cautious", with surveys showing investment and employment intentions below pre-referendum levels.

But household spending has been "rather buoyant", with consumer confidence, retail sales, car sales and an upturn in housing activity all pointing to "solid spending growth", he said.

"That is not too surprising. Household real labour income growth has been buoyant too - close to 3% in the year to Q2, supported by steady employment growth, moderate wage growth and unusually low inflation."

However, the drop in the exchange rate is expected to result in a near 3% rise in inflation next year, squeezing households which are not forecast to see an equal rise in wage growth.

Those factors, along with uncertainty around business investment, is set to slow growth to 1.4% next year.

"There is, as always, significant uncertainty around this forecast. Not least because the tension between the fairly pessimistic assessment by financial markets, the cautious assessment by businesses, and the rather optimistic response by households so far, cannot last."

Mr Vlieghe said that the way that "tension" is resolved will determine how the UK economy "evolves" over the coming years.

He added: "It might turn out that financial markets are too pessimistic and the economy continues to grow in a 'business as usual' way, in which case I would expect the exchange rate to move higher over time.

"Or it might mean that households are too optimistic, in which case I would expect households to reduce spending growth over time, possibly by more than the income-related slowing that is currently the MPC's central projection.

"As always, a good forecast is one that has risks on either side, not just on one side."

The external MPC member went on to defend the Bank's stance on monetary policy, batting away criticism that ultra-low interest rates are damaging the economy and making it more likely to get stuck in a "low inflation trap".

UK inflation came in at 0.9% in October, according to the Office for National Statistics (ONS), below the Bank's own target of 2%.

However, he stressed that low interest rates are not the cause of, but a response to, economic conditions.

"L ow interest rates together with low inflation have indeed been observed in many economies, so commentators wonder whether low interest rates might actually cause low inflation. Umbrellas together with rainfall are also observed in many countries.

"Nobody actually believes that umbrellas cause rainfall."

While Mr Vlieghe, admitted that there is a level at which low interest rates can knock growth, that benchmark is "close to, but a little above, zero" for the UK economy.

The Bank of England's own interest rate currently stands at 0.25%, having been cut to a record low in August.