The Bank of England (BOE) is considering various options for a policy response to a possible ‘no-deal’ Brexit, aimed at supporting growth, investment, and business activity, while also keeping inflation in check, and maintaining the pound sterling’s FX rate stability.
Kristian Rouz – A top Bank of England (BOE) policymaker warns that the UK’s interest rates are set to rise quicker than previously expected, as Brexit fears have mostly failed to materialise, while ultra-low unemployment and robust inflation are making the case for tighter monetary policies.
However, the UK is bracing for a major change in its political leadership, electing its next Prime Minister in July, and it remains unclear what stance the new leader will take on Brexit and the UK’s post-Brexit foreign economic relations.
Some say a ‘hard Brexit’, or leaving the EU without a deal, could pressure the BOE to actually cut interest rates to support economic growth. However, a spike in inflation, expected as part of that scenario, would make it harder for the BOE to loosen policies without risking pushing inflation even higher.
Still, BOE Deputy Governor Ben Broadbent believes Brexit will likely go smoothly regardless of the elevated political concerns, allowing the central bankers to continue normalising monetary conditions in the UK.
“Were the economy to develop in line with our projection, and taking as given other asset prices in the forecast, interest rates would probably have to rise by a little more than what was in the curve at the time of the forecast,” Broadbent said in a Parliament hearing Tuesday.
BOE interest rates currently stand at 0.75 percent following the most recent quarter-percent hike last month. Meanwhile, UK inflation rose to 2.1 percent in April – just slightly above the BOE’s 2-percent target, and up from 1.9 percent in February and March.
The BOE’s recent move on rates is expected to contain possible gains in inflation in the near-term, unless the pound’s FX rate drops following an election of a hardline Brexiteer as the UK’s next Prime Minister.
External BOE member and Citigroup economist Michael Saunders believes the central bank should continue raising rates at a quicker pace as long as macroeconomic conditions allow for gradual policy normalisation.
Saunders believes the BOE needn’t wait until political uncertainty and Brexit-related fears subside, as such factors have only had a limited impact on broader GDP growth over the past three years.
“It may be quite reasonable for markets to take a different view of possible Brexit outcomes. We will go on trying to explain our views on the economic outlook as clearly as possible and the monetary policy implications of that,” Saunders said.
Meanwhile, British investors disagree with the central bankers, saying the economy isn’t strong enough to warrant further rate hikes at this point. In April, the UK economy contracted by 0.4 percent amid a drop in manufacturing output, the Office for National Statistics (ONS) said.
Sceptics also point to a recent report from the National Institute of Economic and Social Research (NIESR) which suggested the British economy could contract by 0.2 percent in 2Q19 after a solid expansion in the previous quarter.
Market participants are urging a cut in BOE rates to support lending and business activity, which would in turn allow them to prevent a possible recession – inflicted largely by Brexit-related concerns.
But manufacturing groups say the ONS’ reporting is inaccurate due to officials underestimating the actual size of Britain’s industrial capacity.
“In particular, policymakers need to be able to measure manufacturing in a way that better reflects how firms actually organise themselves into value networks,” Eoin O’Sullivan of Cambridge University wrote in a recent report for the Department for Business, Energy and Industrial Strategy (BEIS).
Some economists point out that the US Federal Reserve could reserve its policy course and start cutting its own interest rates – ending the three-and-a-half year tightening cycle. If that happens, the BOE could find itself in a confusing situation.
On the one hand, continuing to raise rates in the UK amid an easing on the US side could attract new investment into Britain. On the other, the pound could skyrocket against the dollar, decimating UK exports and global competitiveness, which would negatively reflect on GDP growth in the longer-run.
Meanwhile, the BOE’s Broadbent admitted a ‘no-deal’ Brexit could pose a major challenge to British policymakers. He said interest rates could go either ways in case such a scenario takes place.
Should inflation spiral out of control, the BOE would have to hike aggressively despite the risk of a possible recession. However, if GDP growth and investment tumble first, the BOE would be more inclined to cut rates in Brexit’s immediate aftermath.