The Bank of England governor has warned that Brexit will negatively impact the UK’s economic growth “for the foreseeable future.” Speaking at the G30 40th annual International Banking Seminar, Andrew Bailey said the country’s potential growth rate had declined from 2.5% to 1.5% over the last 15 years. He linked this to lower productivity growth, an ageing population, and trade restrictions, including post-Brexit economic policies.

But Mr Bailey added that the economy is likely to adjust and find “at least partial” balance again in the longer term. “For nearly a decade, I have been very careful to say that I take no position per se on Brexit, which was a decision by the people of the UK, and it is our job as public officials to implement it,” he told attendees at the Washington DC event.

“But I quite often get asked a second question: what’s the impact on economic growth? And as a public official, I have to answer that question.

“The answer is that for the foreseeable future, it is negative. But over the longer term, there will be – because trade adjusts – some at least partial rebalancing.”

The governor’s prediction comes as Chancellor Rachel Reeves prepares for next month’s budget, where she has been pressured to make further tax rises after official figures showed muted growth in August following a surprise contraction in July.

Referencing the works of 18th century economist and philsopher Adam Smith, Mr Bailey said: “That’s the Smithian model: making an economy less open restricts growth over the long term.

“Longer term, you will get some adjustment. Trade does adjust, it does rebuild. And all the evidence we have from the UK is that is exactly what is happening.”

The Office for National Statistics (ONS) said gross domestic product (GDP) rose by 0.1% month-on-month in August and fell by 0.1% in July.

In the three months to August, GDP also grew by 0.3%, compared with 0.2% growth in the year to July.

This follows the International Monetary Fund’s forecast earlier this week that inflation in the UK is set to surge to the highest level in the G7 in 2025 and 2026.

Gloomy economic data published by the Bank of England has raised the spectre of “severe stresses” for UK businesses and a consequent credit crunch.

The Bank has warned that global financial markets are increasingly vulnerable to shocks following a “spike in volatility” over the summer.

In its latest Financial Policy Committee (FPC) report economists offered reassurance that the UK banking system remains robust enough to withstand tougher economic conditions and continue supporting households and businesses.

Nevertheless, there are choppy times ahead, particularly in vulnerable sectors.

While risks to UK financial stability have remained broadly unchanged since June, the FPC highlighted that uncertainty surrounding global geopolitics and economic forecasts remains elevated.

Tensions in the Middle East, in particular Israel‘s ground offensives in Lebanon, have only added to the volatility.

The FPC noted a “short-lived spike in volatility and declines in global equity markets” in early August, driven by disappointing US employment data and underwhelming financial results from major technology companies.

Although positive macroeconomic news soon followed, prompting asset prices to return to “stretched” levels, the fragility of the markets remains a concern.

The report warned: “Markets remain susceptible to a sharp correction, which could affect the cost and availability of credit to UK households and businesses, with investors sensitive to short-term developments in a challenging global risk environment.”

Businesses and banks needed to be “prepared” for “severe but plausible stresses”, it added.

Despite the resilience shown by UK mortgage-holders, with home loan rates starting to fall, the FPC flagged ongoing pressure on lower-income households and renters.

Roughly a third of mortgage-holders have yet to refinance at higher interest rates, which could add further strain.

UK businesses, too, have demonstrated resilience, but the report stressed there are “pockets of vulnerability,” especially among private equity-backed firms and small and medium-sized enterprises (SMEs).

Insolvencies remain concentrated in sectors such as construction, retail, accommodation, and food services, where smaller businesses are facing increasing financial stress.

With the global risk environment intensifying, the FPC’s warning underlines the growing pressures that could soon manifest as severe challenges for UK businesses across several sectors – in effect a credit crunch.

The phrase, coined during the financial crisis of 2007/2008, refers to a situation where there is a significant reduction in the availability of loans or credit from banks and other financial institutions. This often occurs suddenly and can result from various factors, such as increased default risks, economic uncertainty, or a lack of liquidity in the banking system.

During a credit crunch, banks become more reluctant to lend, impose stricter borrowing conditions, or raise interest rates, making it difficult for businesses and individuals to access the funds they need.

This tightening of credit can slow down economic growth, as businesses may struggle to finance operations or expansion, and consumers may find it harder to borrow for major purchases such as homes or cars.

A credit crunch can also lead to financial instability, particularly in sectors that rely heavily on borrowing.

City analysts have issued a warning that the pound reaching its highest level against the dollar in over two years could potentially harm the UK’s international competitiveness. Sterling currently stands at $1.34, its peak since February 2022 and a significant rise from its low of $1.03 following Liz Truss’ mini budget.

Despite the apparent positivity of a strong pound, economists caution that the reasons behind this surge may not be as favourable. “As the fourth largest exporter in the world, the recent rise in sterling is rather unwelcome to the UK as it has a potential to damage international competitiveness,” said Ross Yarrow, managing director of equities at Baird.

The pound’s recent strength largely stems from predictions that the Bank of England will find it difficult to further reduce interest rates, unlike the US Federal Reserve which is anticipated to drastically cut rates. “American central bankers are overtly dovish, while their British counterparts are cautiously hawkish,” clarified George Lagarias, chief economist at Forvis Mazars.

“Markets are now pricing in three more cuts by the end of the year, a total of five in the US. The Bank of England, in contrast, has chosen a much more careful language around inflation, allowing markets to price in two to three cuts.”

The surge in the value of the pound, as traders flock to benefit from higher UK interest rates compared to those across the Atlantic, has sparked excitement among investors, even as the rest of the UK eagerly anticipates further cuts. “While the pound reaching $1.40 may be good for holidaymakers, it would not be such good news for mortgage holders,” commented Matthew Amis, investment director at Abrdn, as reported by City AM.

Yet, the pound’s climb isn’t solely attributed to Federal Reserve actions; it’s also showing strength against the euro up five per cent against the dollar and 3.6 per cent versus the euro since the year’s outset, points out Alex Crooke, portfolio manager of The Bankers Investment Trust. He attributes this robustness partly to the UK “starting to attract international capital both buying gilts and equities”, alongside a politically stable homefront juxtaposed with uncertainty abroad.

All eyes are now on the future movements of British currency. Economists universally acknowledge one key determinant: It’s all about the budget.

“Between now and November, Rachel Reeves will deliver her first Budget, this will be fundamental to how the Bank of England positions itself going into 2025,” notes Amis from Abrdn.

The UK might be holding its own against inflation for now, but precarious times lie ahead. Amis cautions that Reeves’ upcoming fiscal decisions are critical to avoiding a reignition of the inflationary spiral.

“If she does, the result will be interest rates at higher levels for longer and a stronger pound.”

The days of monthly inflation figures exceeding expectations and causing a stir on trading floors around the Square Mile seem to be over. The latest figures released this morning were more subdued, with the headline rate remaining steady at 2.2 per cent, exactly as predicted.

While there were some worrying signs beneath the surface, none were significant enough to cause alarm among the Monetary Policy Committee (MPC) members. Core inflation and services inflation, which are better indicators of underlying price pressures than the headline measure, both saw slight increases in August, but these were largely anticipated.

Services inflation, which has been a major concern for rate-setters in recent months, actually came in slightly below the Bank of England’s November forecasts. It increased to 5.6 per cent in August, up from 5.2 per cent the previous month.

This was mainly due to ‘base effects,’ reflecting the impact of last year’s figures on the annual comparison. Some of the other strength in services inflation could be attributed to changes in erratic areas.

For instance, air fares rose by 22 per cent month-on-month, marking the second highest increase on record. However, the MPC’s measures of underlying services inflation often exclude these more volatile components, as reported by City AM.

An announcement is expected from the Bank of England soon.

Matt Swannell, chief economic advisor to the EY Item Club, has commented that the recent rise in services inflation is expected to be “prove temporary”.

Food and energy prices have also risen less than anticipated, reinforcing the notion that inflation is largely under control.

However, this doesn’t mean an immediate rate cut from the Bank of England is on the cards, as services inflation remains high enough to cast doubt on a swift return to the two per cent target.

Ruth Gregory, deputy chief UK economist at Capital Economics, remarked: “There’s no denying that services inflation is still too high for the Bank of England’s liking.”

With regular pay growth staying above five per cent and unemployment dropping to 4.2 per cent, the labour market appears to remain tight.

Consequently, the general expectation is that the Bank of England will maintain rates tomorrow.

Nonetheless, economists are forecasting a gradual moderation in these indicators throughout the year, which should lead to at least one more interest rate reduction.

Sanjay Raja, chief UK economist at Deutsche Bank, believes the Monetary Policy Committee (MPC) will likely interpret the data as a “positive sign that underlying price pressures are easing”.

A rate reduction in November seems probable at this point, but the future trajectory is unclear. It’s important to note that one of the factors contributing to the expected easing of inflationary pressures is the maintenance of relatively high interest rates, so a swift rate cut by the Bank is unlikely.

However, it’s becoming increasingly evident that rates can continue to be lowered without triggering an inflation rebound.