The Bank of England’s rate-setting Monetary Policy Committee met yesterday against a backdrop of positive data from the Office of National Statistics last week, which confirmed that the economy has so far weathered the post-EU Referendum storm remarkably well.
A 0.5% quarterly improvement in output was not only stronger than most economists had been expecting, but well above the 0.1% forecast the Bank of England had predicted in its August Inflation Report
However, it was driven exclusively by services, which rose by 0.8%, apparently bolstered by the rush to see a number of summer blockbusters, including the latest Star Trek film.
By contrast, manufacturing and construction both posted quarterly declines.
It can be easy to conclude – and many commentators have – that this simply reflects the unbalanced nature of the UK economy, which has long been over-reliant on the service sector.
But could leaving the EU accomplish what numerous policy makers have failed to achieve over the last forty years – create a more balanced economy?
The pound in pain
The 20% drop in the pound since late last year has given a significant boost to UK exporters’ competitiveness.
It seems the pound can’t catch a break. Despite the much better-than-expected GDP and the welcome announcement that Nissan remains committed to production in Sunderland, the UK currency managed no more than a fleeting improvement last week.
With meaningful EU negotiations unlikely to start until after the French and German elections next year, there appears little prospect of this uncertainty fading anytime soon, leaving the pound vulnerable to continued bouts of weakness.
And while we still have access to the single market, this should translate into a big boost to UK exports over the next two years.
Of course, the elevated exchange rate will also drive import costs higher, which should serve to incentivise households and businesses to seek out home grown alternatives, benefiting UK manufacturers.
Inevitably, however, the rise in inflation will mean household real incomes will be squeezed, leading to a fall in spending and, with it, a slowdown in services.
So while the economy may be unbalanced at the moment, ironically the shock referendum result could well deliver a more balanced economy and a much-needed improvement in the balance of payments.
A conclusion to rate cuts?
As we’ve seen, the economy has outperformed most expectations since August, when Mark Carney hinted that the committee were minded to cut interest rates again – to around 0.1% - if the economy evolved ‘broadly’ as expected.
With the pound having fallen further, inflation rising sharply and the economy holding up well, we now expect the Bank to keep rates on hold.
Indeed, with the focus now shifting towards the need for more fiscal rather than central bank support, if rates are unchanged this week, we may have seen the end of this rate-cutting cycle.
By Adam Chester, head of economics, Lloyds Bank Commercial Banking