Mild recession could be a major headache for Bank of England

The words 'mild recession' seem to be the order of the trading day; that a post-Brexit Britain could be staring at two quarters of 0.1%-0.2% of negative growth sometime soon.

The hypothesis gained further traction on Wednesday (3 August), after it was confirmed that services sector activity – considered the mainstay of the UK economy – fell to its weakest level in July, since February 2009.

The sector's Purchasing Managers' Index (PMI) – a measure of decision makers' sentiment within the services sector – as gauged by IHS Markit and the Chartered Institute of Procurement & Supply (CIPS), remained unchanged from the initial estimate of 47.4, down from 52.3 in June and the lowest since March 2009. A reading below 50 points to a contraction.

Worryingly, construction and manufacturing sector PMIs narrated a similarly sorry tale earlier this week. While PMIs, by their very nature, are sentiment surveys rather than data based on actual economic activity – that the mood of purchasing managers is so dour is guaranteed to spook the Bank of England.

With the services sector accounting for two-thirds of economic activity in the UK, IHS Markit chief economist Chris Williamson said an August rate cut was a near given. "The unprecedented month-on-month drop in the all-sector index has undoubtedly increased the chances of the UK sliding into at least a mild recession.

"A quarter-point cut in interest rates therefore seems to be a foregone conclusion, though the extent and nature of other non-standard stimulus measures remains a far greater source of uncertainty and the subject of intense speculation."

Williamson is not alone; another 27 market commentators have told me they also expect a mild recession, although a view on when we would see those two quarters of negative growth is by no means unanimous. Some reckon negative growth in the third and fourth quarters in 2016, would leave us staring at one by January.

Yet others think we may not see it until mid-2017. The most pessimistic scenario, is for the third quarter to see negative growth, the fourth to see some uptick in activity or zero-growth, only for another slump in the first and second quarters of 2017 triggering the much touted mild recession.

Given such a setting, spare a thought for the Bank of England. Interest rates have been stuck at 0.50% since March 2009, having fallen to that record low in the wake of the financial tsunami that hit the global economy following the US subprime crisis.

In dealing with post-Brexit woes, Governor Mark Carney and his Monetary Policy Committee has 50 basis points to play with before the UK does a Japan and goes to zero interest rates. A 25 basis points cut is what the market expects, and that too sooner rather than later, and perhaps an expansion of the quantitative easing programme to accompany it.

Pressure is growing for a response, even though we saw, from July's MPC meeting, that the market has been wrong-footed by central bank before. In many ways, the scenario has not material altered from last month – ie. market survey sentiment remains negative, real hard data on post-Brexit economic activity is still missing.

Even if we take a rate cut as a given, Ben Brettell, senior economist at Hargreaves Lansdown asks the question on every money market analysts' lips – will it work?

"In many ways by talking about a rate cut, the BoE has already achieved much of the intended effect, with bond yields [the cost of borrowing] falling across the board. However it's difficult to see a cut moving the dial too far in the real economy. Money is already cheap, and while lower rates will reduce borrowing costs slightly, they aren't going to significantly alter corporate or consumer behaviour."

Brettell has a point. For at least the last half decade, the savers among us, fund managers and economists have believed a rate rise is just around the corner. Chatter about a rate-rise was actually all the rage last Christmas. Yet, half-year on, in this new post-Brexit Britain we're talking about the exact opposite.

Furthermore, a lower pound is raising inflation expectations and controlling it requires raising rates rather than cutting it. This represents a major dilemma for the BOE and could keep some MPC members in check, prompting them to demand more hard data before an actual rate cut.

Or there have been instances of central banks cutting or raising interest rates by 10 basis points in order to send a market signal. If symbolic gestures is what the market demands a month and a half on from Brexit, the BOE could go down that route. But regardless of what it does, a major headache is on the horizon.

Gaurav Sharma is the Business Editor of IBTimes UK. He has been a financial journalist for over 15 years, with a core specialisation in macroeconomics and commodities. Follow Gaurav on Twitter here.