(Bloomberg) -- Mark Carney said Brexit is casting the biggest shadow over the U.K.'s economic outlook, as his confidence in an orderly departure from the European Union starts to fade.
The Bank of England governor's comments follow slow progress in the initial round of exit talks after Prime Minister Theresa May lost her parliamentary majority in June. Carney said that there's only so much monetary policy can do as the central bank cut its forecasts for economic growth and wages.
“The assumption of a smooth transition to a new economic relationship with the EU will be tested,” Carney said at a press conference Thursday, speaking after the announcement to keep rates at a record low. Of the all the factors determining the economy's fate, “the most important is the outcome of the Brexit negotiation,” he said.
The governor's warning of a potential economic hit, some of his most pessimistic remarks since the Brexit vote, place him in the middle of a debate that has divided the prime minister's cabinet. His comments about the need for a transition period make him a backer of Chancellor of the Exchequer Philip Hammond. Signs the economy is slowing and June's election result have led more members of the government to back such a stopgap.
Britain has until March 2019 to negotiate its divorce and a new trade deal with the EU. That's on hold until the end of August, with the two sides clashing on the prerequisites to starting talks on trade.
The bank's latest forecasts factor in “uncertainty about the eventual shape of the U.K.'s economic relationship with the EU,” which “weighs on the decisions of businesses and households and pulls down both demand and supply,” Carney said.
Companies are keeping a lid on pay increases until they know what kind of access they'll have to Europe's market in a few years, Carney said. The BOE cut its forecast for wage growth for 2018 and 2019.
Carney's remarks on Thursday set the stage for more fiery confrontations with parliament's Treasury Committee, some of whose pro-Brexit members called for his resignation last year after he said that leaving the EU would damage the economy. While growth initially held up better than expected, it's slowed markedly this year and the pound's depreciation has driven up consumer prices.
Inflation, at 2.6 percent in June, is above the BOE's 2 percent target. That's crimping household spending, a key driver of the economy, and economists predict any reduction in trade with the EU will ultimately weigh on growth.
Orderly Exit
The BOE's predictions continue to assume an orderly Brexit and are based on a rate hike fully priced in by the third quarter of 2018. Carney said that at the moment, the bank does “not see any material evidence” that businesses “think that the transition would be anything but smooth,” and policy makers still expect investment and exports to at least partially offset any slowdown in consumer spending.
The central bank now projects economic growth of 1.7 percent this year and 1.6 percent in 2018, down from 1.9 percent and 1.7 percent. The downgrades were enough for the majority of the Monetary Policy Committee to keep their cautious stance, with the vote for no change coming in as expected at 6-2.
Ian McCafferty and Michael Saunders maintained their push for a 25 basis-point increase, which would reverse the rate cut put in place a year ago this week.
The bank also said that a response to above-target inflation and domestic price pressures will be needed eventually. If the economy performs as it expects, the benchmark interest rate will need to rise by a “somewhat greater extent” than markets currently anticipate, it said.
The pound fell after the announcement and was at $1.3147 as of 5:01 p.m. in London, down 0.6 percent from a day earlier.
--With assistance from Harumi Ichikura Hannah George Emma Charlton Alessandro Speciale Catherine Bosley Carolynn Look Marcus Bensasson Andrew Atkinson Lucy Meakin and Simon Kennedy
To contact the reporters on this story: David Goodman in London at dgoodman28@bloomberg.net, Jill Ward in London at jward98@bloomberg.net.
To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Brian Swint, Emma Charlton
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