12 July 2016

CBI Economic Report

Prior to the referendum, the UK economy was on a largely steady footing. GDP rose by 0.4% in Q1 2016 - somewhat slower than the average over recent years, but still a decent expansion. The CBI's growth indicator pointed to similar momentum since.

It's still too early to fully assess the economic impact of a Brexit - we'll see the earliest indicators for the post-referendum period start to trickle in from around mid-July. But it's almost certain that we'll see some deterioration in growth. The key question for policymakers is the timing and extent of any impact on business investment. If this is seen as temporary, the impact on economic growth will be more contained.

The impact of the referendum result on growth - via business and consumer confidence, spending and trade - will be affected by how long the period of financial volatility lasts and the level at which financial markets settle. This will in large part be influenced by how well policymakers are able to manage any emerging financial strains; and whether political developments at home and in the remaining EU members support expectations for an orderly negotiated exit.

The Bank of England's policymakers face a dilemma between, on the one hand, the need to support activity in the midst of a shock to domestic confidence and credit costs; and on the other, minimising the inflation risks arising from a weaker exchange rate and the hit to the UK's potential growth over the longer-term. Given the current dovish inclinations of the MPC, it seems likely that the Bank will prioritise supporting growth and "look through" a rise in inflation, announcing some form of monetary easing - most expect a cut in interest rates (likely in August, assuming a more stable exchange rate). Indeed, in a speech on 30th June, BoE governor Mark Carney stated that "in my view ... some monetary policy easing will likely be required over the summer."

Standard & Poor's and Fitch downgraded their ratings for UK sovereign debt on June 27th (from AAA to AA, and AA+ to AA, respectively). Gilt yields have fallen alongside global yields, reflecting safe haven investment flows within the UK and expectations of lower interest rates. Because UK gilt yields have fallen further, the Bank may be more likely to look at rate cuts rather than further QE.