Publication of the November Bank of England Quarterly Inflation Report was not an implicitly noteworthy event. Currency markets were focused on the will-they-won’t-they of Brexit timelines and deals on the Irish border or financial services. However, for Governor Mark Carney and the rest of Threadneedle Street, a continued focus on the future of interest rates was thrown into sharp relief; do not expect a ‘no-deal’ scenario to automatically lower interest rates in the UK.
In 2016, the Bank’s response was an emergency interest rate cut in order to support demand within the British economy. Since then, growing inflation risk, as well as a labour market that is comfortable with higher wages, has enabled the Bank to raise the base rate twice and we now have borrowing costs at their highest level since 2009.
Since 2009, the instability of the global financial crisis has been swapped out for the uncertainty of Brexit negotiations, and the two-way risk of threats to both the demand and supply sides of the UK economy. These risks are magnified in the event of a no-deal Brexit and have seen the Monetary Policy Committee heighten the tone of their disapproval towards such an outcome.
Mark Carney and the rest of the Monetary Policy Committee are not negotiating Brexit. But warnings that the base rate may not be as accommodative as expected in a no-deal scenario are the most overt attempt to shift the debate so far.
‘No-deal’ to leave the UK in short supply?
The argument of the most recent Quarterly Inflation Report is that the impact of a no-deal Brexit may be a lot more pernicious for the supply-side of the UK economy. The Bank fears that labour shortages, disruption at the border and at ports as well as the desire for businesses to move production, staff and capital abroad will compress the UK economy in such a way that lower levels of growth will push inflation above the Bank of England’s 2% target. In doing so, the Bank of England, according to its mandate, would need to raise interest rates to bring inflation back towards target.
Central banks chose growth over inflation in response to the global financial crisis and I think they will do so once again in the event of a no-deal Brexit.
Of course, this will exacerbate the expected weakness in sterling that would likely materialise in a no-deal scenario – such an event could see GBP/USD test 1.15 and EUR/GBP run close to parity.
Needless to say a deal knocks this risk on the head and the Bank of England will likely continue its ‘gradual but limited’ series of rate hikes that, for now, look to be at a rate of 25bps every six months. That being said, given the base rate was hiked in August, that would mean a hike in February, and we cannot pencil that in until a deal is signed.
For the Bank, as well as everyone else, certainty is the one thing that nobody can price at the moment.
Jeremy Thomson-Cook is Chief Economist and Head of Currency Strategy at WorldFirst.
