The Bank of England governor calmed nerves with a £150bn lifeline, but there are many more post-referendum challenges

Bank of England governor Mark Carney faces his second test since the EU referendum this week after calming markets with his promise to underpin the banking system with an extra £150bn of backstop funds.

On Thursday he will join the other eight members of the central bank’s monetary policy committee (MPC), which sets the UK’s interest rate, and ask: is this a time to push up rates to stifle a possible surge in inflation or the moment to cut them as the economy appears to falter?

Andrew Sentence, a former member of the MPC, says there is not enough hard evidence to move either way. The economic adviser to accountants PwC says it would be much better to wait and see.

But Carney has hinted strongly that he is minded to cut rates after a frantic two weeks that have seen the pound tumble to a 31-year low.

Most City economists expect a rate cut by August, believing that the UK economy is already on the ropes after a slowdown going back to at least last summer – and the markets are expecting it after Carney’s comments. They want some action to offset the lack of decision-making in Westminster while the Tories choose a leader and Labour contemplates ousting Jeremy Corbyn.

Jonathan Loynes, chief European economist at Capital Economics, said the committee will recognise the dangers of disappointing market expectations and cut bank rate by 0.25% before restarting its quantitative easing programme in August.

“The outlook for monetary policy, like the economy, is highly uncertain. But the MPC has ammunition to cushion the impact of the Brexit vote. It should not hesitate to use it,” he said.

Against this challenging backdrop, what is the financial and economic outlook for the UK?

The pound

Sterling slumped to a 31-year-low of $1.28 last week before settling at just under $1.30, having stood at $1.50 on the day of the referendum, and $1.57 last year.

Holger Schmieding, chief economist at Berenberg bank, says that the current uncertainty has driven away foreign investors, reducing the demand for sterling. He says the pound’s fall has stopped for the moment, but it could start again if the current political uncertainty continues.

Unlike Tory leadership candidate Andrea Leadsom, he denies that a cheaper currency automatically boosts exports. “It will be limited,” he says, pointing to the failure of exports to gain any traction after the 2008 financial crisis when the pound lost 20% of its value.

Instead, imports become more expensive, pushing up the average price of goods in the shops. Two straws in the wind are the Chinese computer maker Lenovo, which has hinted prices are set to rise. And higher cocoa import costs are putting pressure on chocolate makers to raise prices.

Mohamed El-Erian, chief economic adviser to Allianz, Europe’s largest insurer, said: “Think of sterling as facing a double whammy with no strong anchor.”

The UK’s balance of payments deficit of 7%, the largest in the G7, is one of the problems which he highlights. It shows that Britain has been living beyond its means for some time.

The lack of Bank of England firepower is another problem. In times past, Threadneedle Street would increase interest rates to protect the pound from going into freefall, but that option is no longer open. Near-zero interest rates are the only thing keeping the economy moving.

“It is not inconceivable for sterling to head to parity with the dollar over the coming months,” El-Erian said.

The markets

The FTSE 100 is higher than it was in the days before the referendum, giving the appearance of calm at the result. The index, which measures the value of London’s 100 largest listed firms, was hovering at 6591 on Friday, well above the 6338 seen before the vote.

However, the gains mask huge falls in the share prices of banks and housebuilders, which took a beating as investors feared a post-Brexit property crash. Insurers have also closed their property investment funds to withdrawals to stem the flow of redemptions.

There was also cause for concern in the FTSE 250 index of medium-sized firms, which stood at 17333 before the vote and finished last week at 16198, down almost 10%.

The FTSE 250 is almost quaintly British, with most making sales in sterling. For these companies the fall in the currency means they become less valuable whereas the generally larger, multinational firms in the FTSE 100, which earn most of their revenues abroad in dollars, climb in value.

Members of the MPC are therefore likely to discount the good news and focus on the underlying weaknesses. And they know that the apparently stable situation can only be celebrated by Brexiters because of the intervention the Bank of England and the European Central Bank, which signalled after the vote that they stood ready to loosen monetary policy further in the event of a panic.

Facebook Twitter Pinterest A fall in car sales showed that consumers were holding off big purchases before the EU referendum. Photograph: Bloomberg

Manufacturing

According to industry figures for June, car sales dropped for only the second time in more than four years. This was widely seen as a sign that consumers, concerned about the outcome of the referendum vote, were feeling less confident about spending money on big-ticket items.

The knock for the usually buoyant car market came after UK factory output made only tentative gains in June. The rise, which followed a slump in the spring, failed to prevent firms shedding more jobs.

Siemens, which has just opened a £310m manufacturing hub in Hull that employs 1,000 people, warned new windpower investment plans were on hold. Many other big employers have voiced their concerns about the impact on investment of Britain moving out of the EU.

Manufacturing output is still around 8% below its 2008 peak and employs many fewer people than before the financial crash, so it needs all the investment it can get.

The core sectors covering aerospace, cars, pharmaceuticals and machine-tool manufacturing remain the UK’s strengths, and the resurgence of activity in the eurozone this year has seen a steady rise in exports to the UK’s main trading partner.

Rob Dobson, senior economist at financial data providers Markit, said the export sector remained tough. Exports fell in May and the low pound may generate more uncertainty, especially in the eurozone, than it does extra sales.

Construction

Builders are wary of another property crash after almost being wiped out in 2008. This sensitivity means the industry, in any country, acts as an early warning system for an impending recession.

For last six months firms have put new projects on hold and concentrated on those already under construction. A skills shortage across the sector has also encouraged them to batten down the hatches rather than take on extra costs. Commercial developers, which build office blocks, shopping centres and factories, followed suit believing rightly that their dependence on foreign investors meant they were more exposed to a period of recession.

Not surprisingly construction-sector shares have been among the worst hit on the stock market since 23 June, with some firms losing a quarter of their value.

Cast out of the EU, many firms fear the UK will suffer slower economic growth and mothballed projects will stay under wraps while immigration restrictions will make recruiting skilled staff more difficult.

Services

The UK’s myriad service industries, which make up more than 75% of the national economy, have supplied almost all the country’s growth over the last five years and helped to offset a huge deficit in the balance of trade in goods.

The most recent figures from the Markit/CIPS purchasing managers index show activity levels at 52.3 – the lowest rating for three years – as new business weakened and firms used their spare capacity to tackle backlogs. The index indicates growth when it rises above 50.

For the last two years economists have feared that UK businesses have relied on domestic consumers to spend their savings and borrow to fund purchases. Wage rises averaging 2% and almost zero inflation have also increased the level of disposable incomes.

The recent fall in the pound is expected to increase inflation, bringing to an end this brief period of improving living standards. A shallow recession is expected to follow. Services companies are likely to take a small fall in national income in their stride and, like most businesses, believe that when the Conservative party elects a new leader in September (possibly earlier) and adopts a clear strategy for leaving the EU, the period of uncertainty will ease.

El-Erian said that much depended on whether politicians were able to provide a credible and swift “Plan B” that included a free trade agreement with the EU.

“After the Brexit referendum, the UK has to urgently get its political act together,” he said. “Plan B depends on the politicians in London and across the Channel, but so far they have not stepped up to their economic governance responsibilities.”