No-deal Brexit risk fails to spark BoE action

The Bank of England’s (BoE) monetary policy committee unanimously voted to keep interest rates on hold amidst growing uncertainty and market pressure for stimulus.

The BoE’s latest Quarterly Inflation Report suggests that growth will slow in 2019, and not recover until 2021 assuming a smooth Brexit. The GDP growth forecast has been downgraded for 2019 and 2020, but revised higher for 2021. According to governor Mark Carney, the weaker global economy is a factor as the trade war between the US and China escalated this year.

Uncertainty from Brexit has also played a role as the contraction in domestic business investment is now expected to continue into 2020, before a rebound in 2021. Household spending is assumed to remain subdued, again, in response to Brexit uncertainty.

Due to the lower growth profile, the BoE now expects excess supply to build in the economy over the next year, before reversing and turning into excess demand by 2022 as the economy recovers. The inflation forecast has been nudged higher in each year, but the near-term weakness in growth should mean inflation remains below the 2% inflation target this year, before picking up in the subsequent years.

In his press conference, Mark Carney did not draw a clear distinction between the Bank’s assumption of an average of all possible scenarios, and the market’s interest rate pricing.

Since the start of the year, markets have steadily lowered the implied path of future interest rates, with the latest showing a greater chance of a cut than a hike. Meanwhile, the BoE has been suggesting that further hikes will be necessary, but has refused to acknowledge the huge elephant in the room – that the risk of a no-deal Brexit is rising, and markets are simply and correctly anticipating it. This has been evident by the recent sharp depreciation in sterling.

The BoE appears to have lost some of its independence if it cannot communicate the true risk of a no-deal Brexit. Of course, Brexit policy is not the business of the Bank, but the potential impact to the economy is. We recognise the Bank is in a difficult position politically, but if the Bank continues to assume the same likelihood of a no-deal Brexit as six months ago, its approach could undermine its credibility.

In contrast, the US Federal Reserve (Fed) has just lowered its main interest rate partly to insure against the growing downside risk from the trade conflict with China. Perhaps the BoE should take a leaf out of the Fed’s book.

Overall, it is clear that the BoE will not be raising interest rates before Brexit. And it will struggle to do so afterwards if first, global growth does not accelerate and second, the UK economy does not rebound materially.