04 May 2016

City AM: Brexit would mean higher inflation and more quantitative easing

Hermes Investment Management warned that Brexit would cause the pound to fall – potentially to around $1.20 – and growth would be hit, putting the Bank of England in a difficult position as it has to deal with rising inflation and slowing growth.

Inflation, which is currently running at 0.5 per cent, is not expected to reach the Bank’s two per cent target until 2018 – if there are no economic shocks, such as Brexit.

Hermes calculated that the fall in the value of sterling associated with leaving the EU could result in inflation hitting two per cent within six months of the vote.

“The pound would fall [after Brexit]. Yet, with growth slowing, loose monetary policy would have to be extended,” said Neil Williams, chief economist at the asset managers.

“Dealing with Brexit and a hit to growth may need to Bank of England to again be a sponsor of gilts, via quantitative easing.”

The Bank currently holds £375bn worth of assets which it purchased during the financial crisis. Mark Carney, governor of the Bank, has said that he will not consider selling these back – in a process called “quantitative tapering” – until interest rates reach at least two per cent.

The Bank has insisted that it stands ready to respond to whatever the economic fallout of a vote to leave the European Union and said that further quantitative easing remains a tool at its disposal.

Without intervention from the Bank of England, Hermes said that the government would also face rising costs in funding its deficit – which came in at £74bn in the most recent financial year.

“Despite saving the annual £8-10bn net contribution to the EU budget, the Office for Budget Responsibility’s GDP and tax revenue projections would have to be revised down, and their gilt-yield assumptions raised. This would eat into the fiscal saving,” said Hermes’ Williams.

Full article on City AM

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