Bank of England keeps policy unchanged

The Bank of England’s (BoE) monetary policy committee (MPC) voted unanimously to keep the policy interest rate on hold at 0.25%, along with its quantitative easing (QE) programme. This comes as it faces criticism from parts of the government over the impact of its policy on levels of inequality, along with the pessimistic nature of its forecast following the Brexit referendum result.

Near-term forecasts have been revised higher

The recent run of better-than-expected growth data for the UK has put the Bank’s forecast in the spotlight, but as stated today, the Bank was not alone in predicting a significant slowdown. Indeed, the Bank was at the more optimistic end of the consensus.

Nevertheless, the BoE revised up its near-term forecast for the UK economy in its latest quarterly Inflation Report. Citing a smaller shock to business investment and robust household consumption, the BoE stressed the high degree of uncertainty when it comes to forecasting political shocks. Although, Governor Mark Carney also partially took credit for the better sentiment, pointing to the stimulus package that was introduced in August.

Higher import prices will hit household spending

While the near-term outlook was revised up, the medium-term forecast for growth was revised down, mainly due to the upward revision in the inflation forecast. The continued depreciation in sterling since August means that import prices are likely to rise further than previously thought, which the BoE thinks will hit households hard in the absence of significant pay growth. Households are therefore expected to cut back spending, which is by far the biggest driver of the UK economy.

Despite the still weak outlook for the UK over the medium term, as inflation is expected to overshoot the BoE’s upper target of 3%, the MPC opted not to add more stimulus at this meeting. In fact, Carney took a decisively more hawkish tone today, introducing the risk of a rise in interest rates should wage inflation accelerate in response to the pickup in imported inflation.

The MPC appears to be willing to tolerate a period of above target inflation in exchange for better growth, and a smaller rise in unemployment, rather than lower inflation but a more negative impact on jobs. This makes sense as in our view, the rise in inflation over the next couple of years is ultimately deflationary, as it will reduce the purchasing power of households and businesses.

No further rate cut expected

Given today’s events, we are no longer forecasting a cut in the Bank’s interest rate, nor an extension of QE. Policy is likely to remain on hold for some time, and we must remember this is still looser than the emergency levels of the global financial crisis.

We now look forward to the new Chancellor’s intervention in the Autumn Statement. We had been expecting significant fiscal loosening later this month; however, given the turnout of growth in recent months, and the pressure from fellow Brexiteers to paint a positive outlook, the Chancellor may be politically constrained in providing support. This may prove to be a mistake once the economy slows.

Government defeated in Article 50 case

Separately today, the High Court ruled against the government in its decision not to allow Parliament to debate the terms of Brexit. While an appeal is likely before the Supreme Court, if the decision stands, then it reduces the government’s ability to prioritise immigration over access to the single market.

Sterling rallied in reaction to the court ruling, although the BoE’s decision today also provided a boost. We doubt the ruling and the debate in Parliament can or would seek to block Brexit, but as Carney said today, the ruling highlights the high degree of uncertainty in the Brexit process.

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