Bank of England Provides ‘as dovish a hike as you get’

Posted by on November 3, 2017

The Bank of England has signalled that its move to boost interest rates for the first time in a decade could quickly be reversed when the stalled Brexit negotiations fall apart.

On Thursday the bank’s monetary policy committee (MPC) voted by a margin of 7-2 to increase its key lending rate to 0.5 percent from 0.25 percent. It was the first rate increases time since July 2007, and many economists and investors consider more hikes are coming within the next few years. However, Bank of England Governor Mark Carney suggested strongly that the growth might be a one-off. Everything depended, he said, how Britain’s negotiations with the European Union proceed and the way consumers and businesses react to the last outcome.

For the time being, those discussions aren’t going well. When British Prime Minister Theresa May triggered the EU’s exit mechanism last March, she hoped negotiations would proceed quickly toward the finalization of a U.K.-EU free trade agreement, along the lines of this Canada-EU trade deal. That has not occurred, and instead, the negotiations have bogged down over a plethora of issues, especially how much Britain should pay to repay its EU financial duties.

And time is running out. Britain officially leaves the EU in March 2019, with or without an agreement. Ms. May has suggested a transition period of about two years to give companies time to adapt to whatever the result, but even that’s not yet been agreed to.

Her leadership has also come into question since she called an election in June that saw her Conservatives lose seats in Parliament, forcing her to form a minority government reliant on support from a little party based in Northern Ireland. Ms. May confronted another blow on Wednesday when long-time cabinet minister Michael Fallon resigned as Defence Minister over allegations of sexual harassment.

Mr. Carney explained that failure or progress on the transition agreement and the closing Brexit deal is going to have a significant influence on the U.K. market and might induce the MPC to raise or lower rates of interest.

“These are not normal times,” he said. “What matters to us is what people think will take place and how they respond to it. A bit more progress or less advancement will matter for the market to the degree to which individuals change their attitudes and change their spending plans both negatively and positively.” Once there’s some clarity “we as a committee might need to step back and evaluate the new perspective and calibrate policy appropriately.”

Mr. Carney added that nearly half of the U.K.’s companies are influenced by Brexit. “Those businesses, generally speaking, are expecting an agreement…They’re anticipating some kind of transition,” he said. The MPC also said in a statement that “the decision to leave the European Union is having a noticeable effect on the economic outlook.”

The Senate and other bank officials have not been bashful in warning about the dangers of Brexit. During the referendum campaign, Mr. Carney faced criticism for issuing gloomy predictions about leaving the EU. This week, a bank official told a parliamentary committee that 10,000 financial services jobs could be dropped on the first day of Brexit when there was no trade deal and that up to 75,000 positions could be cut in the longer term. That led one committee member, Conservative MP Jacob Rees-Mogg, to answer: “Regrettably, the Bank of England is no longer taken seriously since it’s called wolf too many times.”

Mr. Carney said the major reason for a rate hike was mainly because inflation has gone well above the bank’s 2 percent target. Inflation hit a high of 3 percent in September, and the lender believes it will be marginally higher in October. Much of that inflation was driven by the reduced value of sterling, which dropped sharply after the EU referendum in June 2016, inducing import prices to rise.

Mr. Carney explained that with unemployment down to 4.3 percent and the economy growing gradually, “the time has come to facilitate our foot a little off the accelerator … Any future increases in bank rate could be at a slow rate and to a limited extent{}” Financial markets are expecting two more rate hikes over the next few years, taking the rate to 1 percent by 2020.

The bank also revised its forecast for economic growth in 2017, raising it to 1.5 percent from 1.3 percent. It lowered its forecast for 2018 to 1.7 percent from 1.8 per cent, and left its 2019 outlook unchanged at 1.7 percent. Unemployment is expected to remain at 4.2 percent through to 2019.

“This was about as dovish a increase as you get,” said Neil Wilson, senior market analyst in ETX Capital. “In the cautious language, it is more like one and wait-and-see. Further hikes will be ‘at a slow rate and to a limited extent’. With Brexit weighing the prognosis, this could just as easily be reversed next year.”

Sam Hill, senior U.K. economist at RBC Capital Markets in London, also known as the increase “a dovish increase” and said the odds of a further gain in the next 14 months is reduced. “Though the formal assumptions on Brexit did not change — the ‘smooth transition’ remains part of the predictions — there was an acknowledgement of the ‘considerable risks to the outlook’ where EU depart is concerned,” he said. “Our prediction remains that there will not be a additional increase in 2018.”

Courtesy: The Globe And Mail

Posted in: Business Insight

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