Bank of England holds fire as Boris takes on the Brexit battle

02 Aug 2019

Victoria Clarke

Investec Economist

The Bank of England updated its assessment of the economic and inflation outlook at yesterday's Quarterly Inflation Report - will the BoE sit tight on policy for the foreseeable future?

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The UK’s Monetary Policy Committee (MPC) opted to hold policy steady at its meeting today with Bank rate held at 0.75% and with all nine members of the Committee backing this decision. This was fully in line with market expectations and our own forecast. There were also, as expected, no other policy changes announced with QE gilt holdings kept at £435bn and the corporate bond total maintained at £10bn.

Will the BoE bring inflation in line?

The policy decision came as part of the Quarterly Inflation Report in which the Bank of England (BoE) had updated its assessment of the economic and inflation outlook. A key focus for BoE watchers here is the Bank’s forecast for CPI inflation three-years ahead; if above 2% this provides a guide, usually, as to whether the BoE would be looking for a more solid market path for interest rates (than the forecasts are conditioned on) to bring inflation into line with the 2% goal.
The problem this time, however, was that whilst the BoE had based most of its assessment on a smooth Brexit, that assumption had been paired with a set of interest rate projections which built in a far from negligible risk of a disorderly Brexit (Bank rate of 0.5% in 2020, compared against 1.0% in the May projections). Combined together, this “inconsistency” set the stage for a three year ahead inflation forecast of 2.37%. 
Governor Carney continued to argue that the policy response would not be automatic, but that the BoE would do what it could.
Seeking to provide more meaningful analysis for markets, the Bank also presented a sensitivities box in the Inflation Report, under different asset price assumptions which might prevail under a smoother Brexit path. Here, with the market path for interest rates 25bp higher by Q3 2022 (and other adjusted asset price assumptions) CPI inflation would be seen closer to target at 2.1% at this point. With the market path 50bp higher, inflation would be down at 1.8%.
Under these sensitivities, it is clearer why the BoE maintained its advice that increases in interest rates, “at a gradual pace and to a limited extent”, would be appropriate. Note though that this guidance is tied explicitly to the assumption of a “smooth Brexit” and additionally “some recovery in global growth”. Under a more disorderly Brexit, Governor Carney continued to argue that the policy response would not be automatic, but that the BoE would do what it could. He directed listeners however to previous comments he had made on this subject, namely where he previously hinted that personally, he thought it would be “more likely that we would provide some stimulus in that event” [i.e. under a no-deal Brexit].

Brexit uncertainty at the forefront

The linkage of the interest rate guidance to global growth was consistent with a more guarded assessment of the global economic backdrop overall today. Here, 2019 world GDP growth was now seen at just 3% (was seen at 3¼% in the May Inflation Report) whilst the minutes highlight the breadth, across countries, of the relatively soft run of recent economic releases.
At this time, with Brexit uncertainty front and centre and with planned limited rate rises seen as suitably far off, the BoE can easily afford to watch and wait to see if the global backdrop improves. But the minutes appear to give the impression that if and when Brexit uncertainties subside, the Bank would be looking for some reassurance on global growth momentum too, before making any step forward to tighten policy.

Carney keeping cards close to his chest

Over a shorter horizon, it is clearly Brexit (and almost exclusively Brexit) which will determine the policy path. Governor Carney refused to be drawn on the BoE’s own views on the likelihood of a no-deal Brexit and indeed the Inflation Report draws on betting odds and a Reuters survey in its stylised illustrations. He also defended the smooth Brexit conditioning assumption with relative ease, despite the shift in market expectations of the no-deal likelihood under new PM Boris Johnson, saying that the government’s stated policy is to “pursue a deal”.
Beyond this, there were no revealing insights from the BoE Governor over how he sees Brexit playing out, though he did state that we can expect some updated disorderly Brexit analysis from the Bank, probably in September. 
Interest rate markets adjusted a little more amidst the more cautious global growth assessment, to price in a slightly flatter path for rates over the medium term.
Overall, there was nothing in yesterday’s Inflation Report to shift us from our current view that the Bank of England will sit tight on policy for the foreseeable future and certainly well into 2020, under our expected case assumption that a no-deal Brexit is averted. Under a no-deal, we judge that a cut in Bank rate would be likely and we take Governor Carney’s steers today as a further indication that this is the right judgment.
Sterling moves continue to be dominated by news on Brexit rather than fundamental economic information. The same was true of today’s press conference. With sterling already at more than 2-year lows against the USD ($1.2098 at the time of writing) as investors focus on no-deal risks, speculation from the BoE over how policy might move under different states of the world left little discernible mark on the currency. Interest rate markets adjusted a little more amidst the more cautious global growth assessment, to price in a slightly flatter path for rates over the medium term.

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