Brexit may limit Bank of England's capacity to cut interest rates - Carney

Central bank plans two more rate rises in the next three years

Bank of England governor Mark Carney announcing the increase in interest rates at the Bank of England in London last week. Andy Rain / EPA

The Bank of England may be unable to cut interest rates if the UK’s exit from the European Union turns out to be worse than policymakers currently expect,  its governor Mark Carney said.

Because the decision to leave the EU is already crimping supply and trimming the pace of economic growth without fanning prices, the central bank might not be able to provide extra impetus if inflation spins out of control, Carney said on ITV’s “Peston on Sunday.”

When asked if Brexit might prevent the BoE from cutting rates even when growth is slowing, Carney said, “That’s an extreme possibility but it is a possibility,” though “we will supply as much support as we can during this course of adjustment.”

The remarks reinforce Carney’s position that the bank has limited tolerance for faster inflation even though growth is sluggish compared with the past. The BoE raised borrowing costs for the first time in a decade on Thursday to counter inflation that’s already a percentage point above the bank’s 2 per cent target. Carney has said the pace may pick up further.

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On Brexit, Carney said the bank is working on an assumption that the Brexit transition will be smooth, and has signalled two more rate increases in the next three years.

That may change if current negotiations with EU leaders, which resume this week in Brussels, don’t go as planned or the UK fails to reach an agreement on post-Brexit trade with the bloc.

“If we have materially less access than we have now, this economy is going to need to re-orient,” he said. “During that period of time, it will weigh on growth. This is a fundamental, structural change.”

The BoE needs to make sure inflation returns to target and that the financial system can handle any disruptions, he said. He reiterated that the economy can probably only grow about 1.5 per cent a year without stoking inflation, compared with about 2.5 per cent before the financial crisis a decade ago.

Brexit is exacerbating weak productivity growth the UK has experienced since the crisis, he said. The central bank predicts that investment will be about 20 per cent lower now than it expected before the referendum in June 2016.