Uncertainty over trade at a time of increasing protectionism could trigger a "snap back" in interest rates, tightening financial conditions around the world, the governor of the Bank of England said in a speech.
Increased tariffs would cut trade, disrupt supply chains and raise import costs, damaging business and consumer confidence, Mark Carney said in the speech in the northern English city of Newcastle, adding that survey measures of global export orders and manufacturing output have retreated, in a sign that uncertainty is already weighing on activity.
"There is a growing possibility that trade uncertainty could crystallize the longstanding risks of a snapback in long-term interest rates, increased risk aversion and a general tightening in global financial conditions," he said.
The decision of governments not to revert to protectionism in the wake of the global financial crisis in 2008 was crucial to the economic recovery, Carney said. Trade in goods returned to pre-crisis levels after just two years, whereas a slew of tariffs in the aftermath of the Great Depression left trade 20% below the peak level for much of the subsequent decade.
"When combined with the aggressive response of the world’s major central banks, the continued openness of trade after the crisis helped avoid a repeat of the Great Depression," he said.
An increase in tariffs between the U.S. and trading partners of 10% would result in a 2.5% decline in U.S. output and a 1% decline globally, Carney said.
In response, he said monetary policymakers would need to monitor changes to the relationship between domestic slack and inflation which, he said, "could steepen and shift as trade falls back."
In his assessment of the U.K. economy, Carney repeated the sentiment of the BoE's Monetary Policy Committee in its June meeting, with the market interpreting his comments as a signal the central bank will increase interest rates in August. The pound picked up by 0.25% against the dollar to just under $1.33 as of 5:40 a.m. ET.
"Domestically, the incoming data have given me greater confidence that the softness of U.K. activity in the first quarter was largely due to the weather, not the economic climate," he said, noting that the labor market "has remained strong," with pay firming and headline inflation ticking up on higher energy prices.