19 June 2023

Why Mark Carney is wrong about Brexit (again)


True to form, Mark Carney has made another unhelpful intervention in the Brexit debate. This time his remarks have generated more heat than light on the impact that the vote to leave the EU might have had on UK inflation. And by appearing to validate fears that UK interest rates have a lot further to rise, he has added to the worries facing homeowners.

To be fair, I assume Mr Carney is not blaming Brexit for all of the UK’s inflation problems. Clearly that would be nonsense, because inflation has surged across the Western world. Instead, his claim is presumably that UK inflation is higher and more persistent than it would otherwise have been as a result of our departure from the EU, and that this means UK interest rates will have to be higher for longer too.

Or in his own words:

‘We [the Bank] laid out in advance of Brexit that this will be a negative supply shock for a period of time and the consequence of that will be a weaker pound, higher inflation and weaker growth. And the central bank will need to lean against that. Now that’s exactly what’s happened. It’s happened in coincidence with other factors, but it is a unique aspect of the economic adjustment that’s going on here’.

Nonetheless, the former Bank of England Governor has, once again, gone too far.

One thing the Bank did get right was that the pound fell sharply after the vote to leave the EU. But even if this was due to Brexit (rather than the correction of an overvaluation that would have happened anyway), a fall in the pound in 2016 would not still be affecting inflation in 2023.

The fall in the pound was not even such a bad thing in 2016, because inflation was then too low! In May that year Governor Carney actually had to write a letter to the Chancellor explaining why inflation was more than 1% below the 2% target.

The latest CPI figure at the time was just 0.5% (March 2016) and inflation bottomed out at 0.3% in May. Partly as a result of the fall (or ‘correction’) in the value of the pound, it then recovered to average 2.7% in 2017, peaking at 3.1% in November that year.

In contrast, warnings that a vote to leave the EU would trigger a recession and higher interest rates were immediately proved wrong. Indeed, in August 2016 the Bank (still under Carney) actually cut its official rate to 0.25%, then a record low, and expanded its QE programme.

Rolling forward, there are some ways in which Brexit might have damaged the ‘supply side’ of the economy, at least initially. It has deterred some business investment, added some frictions to trade, and contributed to labour shortages in some sectors. But there is no hard evidence (as opposed to models and simulations) that this is having any significant impact on UK inflation (or, for that matter, overall GDP).

The UK’s current inflation rates are not even as much of an outlier as many assume. ‘Core’ inflation (excluding food and energy) is still higher in several of our European peers, including Sweden, the Netherlands and Austria.

It is also only really in the last few months that UK inflation has stood out from the rest of the G7. This may simply be a matter of timing, and UK inflation should soon fall back too, for the same reasons as it already has in other economies,

In particular, monetary growth has slowed sharply, pipeline price pressures have begun to ease (including energy and food), and the supply chain problems and labour shortages that have contributed to the stickiness of core inflation have started to clear as well.

Taking just a snapshot of the latest annual inflation rates can be misleading too. For example, UK food price inflation is currently relatively high. But food prices have risen by about the same percentage since 2019 as the average in the euro area, and by less than in many countries, including Germany.

In the meantime, there are plenty of non-Brexit reasons why UK inflation might be higher – at least temporarily – than in other countries. One is the continued pass-through of relatively high energy costs in the UK, which still impacts the ‘core’ rate, and the operation of the Ofgem cap.

Another, more positively, is the relative resilience of the UK economy. Germany in particular is already back in recession. Consumer spending has also held up much better in the UK over the last two quarters than in the euro area as a whole. (This, more negatively, might change as the full impact of past rate increases hits the UK mortgage market, but that is also a good reason why UK interest rates should not have to rise as far as many now fear.)

Fiscal and monetary policy decisions also play important roles. Governments in many other countries have been more willing to intervene directly to reduce prices. The UK government has put more emphasis on topping up the incomes of the most vulnerable households and businesses, which is a better approach but has less impact on the headline rate of inflation.

Finally, the Bank of England itself has to take a large chunk of the blame. In particular, the decision to increase the amount of QE further in November 2020 helped to lay the ground for the subsequent surge in inflation.

Of course, it is much easier for current (and past) central bankers to blame external factors for their own mistakes. And while I don’t like playing the man rather than the ball, Mark Carney’s track record in commenting on Brexit is especially poor.

For example, last year he made the obviously misleading claim that Brexit had shrunk the UK economy from 90% the size of Germany’s to less than 70%. This was quickly debunked, but not before it was gleefully retweeted by all the usual suspects.

In short, Mr Carney, please give it a rest.

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Julian Jessop is an independent economist.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.