The Monetary Policy Committee (MPC) who are the policymakers at the Bank of England (BoE) are set to keep interest rates on hold at 0.75% this week.
The MPC are to give their decision officially at noon on Thursday, they are also set to provide positive news as the UK economy figures show gross domestic product (GDP) grew by 0.3% month-on-month in July.
Howard Archer, chief economic adviser to the EY Item Club said, “We expect interest rates to be kept at 0.75% with the MPC firmly in ‘wait and see’ mode.
“Current heightened domestic UK political uncertainties reinforce the case for the Bank of England maintaining a watching brief.”
Inflation has moved up slightly from 2% in June to 2.1% in July.
George Brown, at Investec Economics, said the BoE will have “plenty of domestic political developments to chew over.”
Adding, “It now seems a question of not if but when a snap general election will be held, with both sides of the House of Commons indicating a desire to go back to the electorate.
“Though the MPC will steer well clear of commenting on such sensitive matters, it will need to grapple with the implications of a possible change of government and with it a shift in Brexit policy.”
The UK economy is in contraction mode, but the Bank of England isn’t greatly worried. GDP fell by 0.2 per cent by the second quarter of the year as Brexit uncertainty and a global slowdown held growth back.
Policymakers at the BoE are reluctant to fiddle with interest rates as the Brexit date of 31 October looms. New Prime Minister Boris Johnson has made it abundantly clear that Britain could be crashing out of European Union without a deal.
Noises from the British economy last week will have comforted bosses at the Bank and cemented their “wait and see” position. Inflation was shown to have picked up to 2.1 per cent, wages grew at their fastest pace in 11 years, and July retail sales delivered a pleasant surprise.
It looks, then, like only the shock of a no-deal Brexit would cause Threadneedle Street to tamper with rates, which currently sit at 0.75 per cent. Yet the BoE has repeatedly said that in such an event rates could move “in either direction”.
City economists are not convinced by this argument from Mark Carney and co, however. Peter Dixon, economist at Commerzbank, says: “There would appear to be no good arguments in favour of a hike”.
The Bank’s logic is that a tumbling pound could push up the cost of imports and drive up prices. But Dixon says the effects would only be felt “over a six to 12 month horizon”.
Eventually, he says, the BoE will have “to weigh up” the risks to inflation versus the risks to growth. “But that will not be a calculation they have to make anytime soon”.
Oliver Blackbourn, portfolio manager on the multi-asset team at Janus Henderson, concurs. “In the higher-inflation, lower-growth environment expected,” he says, “the Bank of England will choose to primarily worry about the latter”.
He says lower availability of goods, services and workers for industry as well as consumers worrying about their incomes will weigh on economic growth. “This is likely to be the Bank’s main focus in its decision making.”
Turning the taps back on
Institute of Directors chief economist Tej Parikh says: “The precise shape of a no-deal Brexit and the scale of the government contingencies will play into the Bank’s final decision.”
Sajiv Vaid portfolio manager at Fidelity International takes a similar view, saying that in the event of a no deal, “the lesson to learn is that you cannot rule anything out”.
The shock could be so severe that policymakers might turn to the bazooka of stimulus bond-buying, or quantitative easing (QE), rather than the pistol of interest rate cuts. In even the relatively benign scenario modelled by the International Monetary Fund (IMF), Britain would enter a recession in 2020 and unemployment would rise by 1.5 percentage points.
Dixon says: “The BoE can always resume asset purchases. After all, the BoE balance sheet is only around 28 per cent of GDP – a full 10 percentage points lower than [European Central Bank] levels”
Craig Erlam, senior market analyst at foreign exchange firm Oanda, says a no-deal Brexit would force “at least one rate cut and perhaps additional quantitative easing”. He says the Bank will be hoping that “unlike in the aftermath of the crisis, the government also plays a role in providing an economic buffer”.
Vaid agrees. “I think this time will be different and expect fiscal policy to play its part,” he says. Blackbourn also says he thinks rates would be lowered, “likely alongside a large fiscal easing from the government”.
Almost all economists disbelieve the Bank when it says interest rates could move either way if a no-deal Brexit comes around. Blackbourn says: “Despite the inflation-targeting mandate, the Bank’s first reaction will be to support growth and later worry about inflation.”
Bank of England governor Mark Carney has said his institution will not pursue negative interest rates, a monetary policy device employed by the European Central Bank (ECB) and Bank of Japan, among others.
“At this stage we do not see negative rates as an option here. I am not criticizing others that have used them, but we don’t see it as an option,” he told Central Banking magazine earlier this month in an interview published today.
Negative interest rates seek to encourage banks to spend their spare money by penalising them for keeping it in their country’s central bank.
The BoE has been less willing to cut interest rates than some of its peers. The US Federal Reserve last month cut interest rates by 25 basis points (0.25 percentage points) and the ECB has heavily suggested further stimulus is coming.
Carney’s Bank has kept the main interest rate – which determines the cost of lending in the economy – at 0.75 per cent, citing high employment and inflation close to its two per cent target.
Yet a no-deal Brexit on 31 October, the date Britain is scheduled to leave the European Union, could cause the Bank to lower rates to support the economy during a likely shock.
Carney told Central Banking that negative interest rates can be “counter-productive”. He said the Bank’s view “is that the effective lower bound is close to zero, but positive – just above zero.”
The governor also said he does not think changing the Bank’s inflation target, which is set at two per cent, is a good idea.
“I am not a big fan of changing the target,” he said. “If you are having trouble getting to two per cent it is not clear to me why moving to three per cent really helps.”
The Bank’s favoured inflation rate was 2.1 per cent in July, official figures showed earlier this month. Inflation in the Eurozone, on the other hand, was just one per cent in July, official data showed today.
The pound gained for a second consecutive day on Friday after a stream of resilient economic data this week calmed sentiment on the health of the UK economy and as opposition parties launched plans to block a no-deal Brexit.
British retail sales unexpectedly expanded in July and signaled that consumers were taking the prospect of Brexit in their stride for now, helped by firm wage data and modest inflation pressures, according to data released earlier this week.
“This suggests consumer spending is still holding up and still supporting the economy even though overall output contracted in the second quarter,” said Marshall Gittler, chief strategist at ACLS Global.
“It ties in with the relatively high wage growth that we saw earlier in the week.”
Further fueling demand for the British currency, especially against the euro this week, was growing momentum to try to stop Prime Minister Boris Johnson from taking Britain out of the European Union at the end of October without a deal.
Against the euro, the pound scaled a 11-day high against the single currency, up 0.5% at 91.45 pence.
Versus the dollar, the pound rose for a second consecutive day, up 0.3% at $1.2121 and is poised for its biggest weekly rise since late June.
The opposition Labour party said it would call a vote of no-confidence in Johnson’s government as soon as it believes it can win it and seek to form a temporary government under leader Jeremy Corbyn to delay Brexit.
While derivatives indicate market players may be trimming back some short sterling positions, the currency’s prospects remain clouded by the risk of Britain exiting the European Union without a divorce agreement.
Reporting by Saikat Chatterjee; Editing by Keith Weir
The Bank of England is set to come under pressure to control price growth after inflation in July came in at 2.1%, significantly above analyst expectations.
The figure, released by the Office for National Statistics (ONS) on Wednesday, follows bumper wage growth data earlier this week.
Analysts had predicted that the consumer price index, the measure of inflation used by the Bank of England and the government, would fall to 1.9%, or slightly below the Bank of England’s 2% target.
But the 2.1% growth in prices now suggests that record-low unemployment and high wage growth have now translated into higher consumer spending.
The ONS said on Tuesday that average weekly wages jumped by 3.7% in the year to June, the highest increase in more than a decade.
The Bank of England earlier this month forecast that inflation would fall below 1.6% in the final three months of the year, in part because of lower energy prices.
But the steep decline in the value of the pound in recent weeks has increased inflationary pressure in the UK, largely because it has raised the cost of imports.
The ONS said that higher prices for hotels, video games, and consoles combined with a decline in summer clothing discounts were responsible for the uptick in inflation.
Inflation in June had already hit the bank’s target.
Though markets expect the Bank of England to hold rates steady before the 31 October Brexit deadline, above-target inflation would normally prompt the bank to hike interest rates.
“The latest data will not change the position of the Bank of England, which is committed to keeping interest rates on hold at least until more clarity is provided on Brexit,” said Mike Jakeman, an economist at PwC, in a note on Wednesday.
The data, however, “could well be seen as supporting a hike,” said David Cheetham, chief market analyst at XTB.
Core inflation, which excludes energy, fuel, alcohol, and tobacco prices, also came in above expectations, climbing to a six-month high of 1.9%.
Another measure of inflation, the retail prices index, fell to 2.8%, from 2.9% in June.
That figure is used to determine the extent to which rail prices will be increased from January, meaning that commuters will face a £100 hike in season ticket costs.
Inflation has climbed since the June 2016 Brexit referendum, which prompted a 10% fall in the currency’s value.
The pound had its worst month since October 2016 in July, and earlier this month plunged below $1.21 (GBPUSD=X) for the first time since January 2017.
In normal times, surging inflation would see the bank tighten monetary policy, mostly by increasing its benchmark interest rate.
But the bank is expected to ease its policy stance — in part by lowering rates — in the event of a no-deal Brexit, because the economy will likely need a boost.
Under current guidance from the bank, which assumes that there will be an orderly exit from the European Union in October, the bank has said that it expects to gradually increase interest rates.
The Bank of England (BoE) again left interest rates unchanged at 0.75%, despite the headwinds buffeting the UK economy. The Bank didn’t follow the Federal Reserve and European Central Bank in turning more dovish, though economic growth is expected to be weaker than previously forecast this year and next. The Bank appears to be caught between a weaker near-term growth outlook and expectations that inflation will rise above the 2% target over the next three years. As markets are clearly pricing in interest rate cuts, the Bank is forced to expect rising inflation over the forecast period, despite their own indications that they intend to raise interest rates.
Despite recent commentary from UK government ministers, the Bank of England continued with its assumption of a smooth Brexit transition. The Bank continues to find itself entangled in a web of planning for ‘no deal’ but being unable to use this as an assumption in its own forecasts. This is creating significant inconsistencies between its outlook and the market forecasts that feed into it. Some Monetary Policy Committee (MPC) members have recently provided their opinions on the outlook in the event of ‘no deal’ but the need to remain apolitical continues to prevent the wider committee making a decisive assumption. However, as Governor Carney commented, a no deal Brexit may require a range of different responses depending on the actual outcome and future relationships. A shift to a ‘no deal’ assumption remains potentially the most obvious catalyst for a shift in the Bank’s interest rate forecasts, though this itself comes with additional political risks in the assumptions made.
At some point, if global growth continues to slide and Brexit-related uncertainty remains an additional drag, the Bank might be forced to change its forecasts anyway. In the meantime, the fog of Brexit continues to pervade the decision-making of every UK institution and corporate. This is likely to weigh on sterling and gilt yields in the near term, though breakeven rates may continue to drift higher, in contrast to other major sovereign bond markets.
The Bank of England has voted to hold interest rates at 0.75%, while issuing a grim forecast about the impact of Brexit on growth and the value of the pound.
As anticipated, the nine-member monetary policy committee (MPC) voted unanimously to hold interest rates at 0.75%. They were last revised up a year ago.
However, the Bank’s forecasts for growth were more pessimistic than expected.
With Brexit negotiations dragging on, the chance of a no-deal exit rising, and as the pound plunged, reaching a two-year low this week, the central bank predicted zero GDP growth in the second quarter—before the UK even departs the EU.
The bank’s quarterly inflation report, issued Thursday, also warned there was a one in three chance of a negative growth—a recession—by 2020.
The Bank cited “entrenched Brexit uncertainties” along with escalating international trade tensions and a global economic slowdown, as reasons for the dour forecasts.
“Since May, global trade tensions have intensified and global activity has remained soft. This has led to a substantial decline in advanced economies’ forward interest rates and a material loosening in financial conditions, including in the United Kingdom,” the Bank’s Monetary Policy Committee said.
“An increase in the perceived likelihood of a no-deal Brexit has further lowered UK interest rates and led to a marked depreciation of the sterling exchange rate.”
The recent spiral in the pound—the worst performance of any major currency in the month of July—has been linked to new Prime Minister Boris Johnson’s commitment to leave the EU, deal or no deal, in 100 days.
“These asset prices reflect market participants’ perceptions of the likelihood and consequences of a no-deal Brexit,” the Bank said.
A no-deal exit would send the pound crashing still further, with inflation rising and GDP growth slowing further, the Bank warned.
However, the Bank said it did believe a deal with Brussels, and a smooth Brexit transition, could still be reached—reflecting official government policy to continue pursuing a managed exit.
In that case, the bank said it would likely raise the bank rate over the next three years to combat inflation.
“Assuming a smooth Brexit and a recovery in global growth, a significant margin of excess demand was likely to build. Were that to occur, the MPC judged that increases in interest rates, at a gradual pace and to a limited extent, would be appropriate,” the Bank said.
But while the government is still officially targeting an agreement with Brussels, there are suggestions it is expecting to leave without one. Johnson ally Michael Gove, in charge of no-deal preparations, said earlier in the week that the government was “operating on the assumption” of a no-deal exit on 31 October.
Despite recent expectation that the Bank of England could either raise or even cut the UK interest rates, EY’s economic analysts have predicted the will likely remain the same.
As recently as June, the focus on UK monetary policy has been when the Bank of England is most likely to raise interest rates.
A turnaround in sentiment, however, has led some to believe the Bank of England could be just as likely to cut them.
According to EY’s ITEM (Independent Treasury Economic Model) Club, it would be a surprise for the Monetary Policy Committee (MPC) meeting to result in anything other than a unanimous 9-0 vote in favour of keeping UK interest rates at 0.75%.
Howard Archer, chief economic advisor to the EY ITEM Club, said: “We expect the Bank of England to keep interest rates unchanged at 0.75% on Thursday following a unanimous 9-0 vote of the Monetary Policy Committee (MPC) at their August meeting. This would match the outcome of the MPC’s last meeting in mid-June.
“However, a fair amount has changed since the last MPC meeting in mid-June and this will lead to a lot of interest in the tone of the minutes of the August meeting as well as in the new growth and inflation forecasts contained in the simultaneously released Quarterly Inflation Report.”
The direction interest rates move hinges on Brexit developments. Should the UK leave the EU with a deal in place, the EY team expects that the current rate of 0.75% will remain the same well into 2020, and gradually rise in-line with a slowly growing economy.
The expectation is that the Bank of England will acknowledge the recent increased risk facing the UK economy due to uncertainty surrounding Brexit, but are unlikely to react by cutting interest rates unless there is a damaging ‘no-deal’ Brexit in October.
“Increased belief that the Bank of England’s next move will be to cut interest rates rather than increase them is the consequence of a number of factors,” said Archer. “These include the weakened performance of the UK economy in the second quarter, domestic political uncertainties, a slower and more uncertain global economic environment which is expected to see the Federal Reserve and ECB shortly cut interest rates, and Brexit uncertainty.”
“If the UK ultimately leaves the EU without a “deal”, the Bank of England has repeatedly held to the view that interest rates could move in either direction.”
The view mirrors Bank of England Governor Mark Carney’s comments saying that the prospect of a no-deal is slowing down economic growth, and that the BoE would likely be required to provide stimulus to the economy should a no-deal occur.
Speaking to MPs, Governor Cerny said: “It’s more likely we would provide some stimulus. We have said we would do what we could in the event of a no-deal scenario but there is no guarantee on that.”
“There is not a business investment boom going on in the country right now. I think we all know why that is not the case.”
The fear of further Brexit uncertainty is also reflected in economic predictions. The likelihood is that further delay in leaving the EU could also lead to a cut to interest rates, or at the very least a long delay before any hike.
Archer said: “If Brexit is delayed again – most likely until the end of March 2020 – we expect the Bank of England to hold off from hiking interest rates until further into next year as it gauges how the economy is performing after the UK’s exit from the EU.”
The British Pound is said to already be trading at crisis levels, and as a result it will struggle to fall much lower says an analyst at leading global investment bank.
GBP is already “trading at crisis levels, and will struggle to go much lower,” says Jordan Rochester, foreign exchange strategist with Nomura in London.
That the Pound is already low by historical standards, it would suggest it will take successive bouts of bad news to really push new lows.
We wonder where such news might come from.
The Pound has recovered ground against the Euro over the course of the past 24 hours with news that Boris Johnson would replace Theresa May as Prime Minister on Wednesday.
The Pound-to-Euro exchange rate has recovered to 1.1160, having been as low as 1.1047 just last week.
“The Pound was volatile yesterday following Boris Johnson’s victory speech, as well as remarks from the BoE’s Haldane and Saunders who indicated they are not likely to vote for a rate rise in the near term. The Euro is under pressure ahead of tomorrow’s ECB policy announcement. The ECB is expected to prepare the ground for lower interest rates in September, although there is an outside chance of a reduction as early as tomorrow,” says Hann-Ju Ho, an economist with Lloyds Bank.
We would like to say the Pound is rallying exclusively on news Johnson is taking over, but we expect the picture is a great deal more nuanced: markets have known for weeks Johnson was incoming, and we believe they are now awaiting the next decisive moves on Brexit policy for guidance.
Furthermore, markets will be watching to see whether a General Election is likely in the UK before pulling the trigger on further Sterling declines.
Nomura’s Rochester also makes the point that the change at the top of the UK’s leadership extends well beyond the Prime Minister’s office:
“Over the next few weeks and months, the leadership transition will not only include a new Prime Minister, but a complete changing of the guard. In addition to a new PM, the UK can also look forward to seeing replacements for Chancellor, Cabinet, Bank of England Governor, budget and Brexit plan.
Despite the expected leadership changes, Rochester notes implied volatility levels in Sterling are still below levels seen back in March when markets were showing notable nerves over the prospect of potential big moves around the original Brexit date, and therefore “a lot of the negative news has been priced into spot,” says Rochester.
In short, the Pound is at levels that suggests it has eaten a decent share of bad news.
“GBP already trades at crisis levels and typically struggles to move much lower,” says Rochester. ‘While we acknowledge that a no-deal Brexit is a risk and would very likely record new lows in GBP, we do not expect the market to assign a higher hard Brexit premium than previously or until parliament returns after the summer break in September.”
Above: GBP/EUR since 2009: Sterling is at already-low levels, and it might struggle to fall lower
We believe the conditions for a recovery in Sterling over coming weeks, that coincides with Parliament’s summer break, is a distinct likelihood.
After all, this is a political currency, and with no politicians to bother it the prospect of a recovery grows.
Euro Hit by Dire Manufacturing Data
The Euro was in retreat from a steady Dollar and stronger Pound Sterling Wednesday after IHS Markit surveys for July pointed to a renewed economic slowdown in the Eurozone in the third-quarter, prompting calls for the European Central Bank (ECB) to support the economy with interest rate cuts and more quantitative easing as soon as this Thursday.
The IHS manufacturing PMI fell to a 79-month low of 46.4 in July, from 47.6 in June, when financial markets had looked for it to remain unchanged.
However it was German manufacturing PMI which proved an eye-opener: the German Manufacturing PMI read at 43.1, well below expectations for 45.1.
Anything below 50 suggests contraction, it is therefore little wonder that Euro exchange rates are in retreat on the numbers:
The Pound-to-Euro exchange rate extended its short-term uptrend on the numbers to record a near-month high at 1.1207.
The Euro-to-Dollar exchange rate fell to close in on a new two-month low at 1.1139.
Meanwhile, the Eurozone services sector PMI fell from 53.6 to 53.3, in line with the market consensus.
The composite PMI, which combines the two previous surveys, fell from 52.2 to 51.5 this month suggesting that while the economy is still expanding it is close to stalling.
New order flows stagnated in the manufacturing sector this month and confidence hit its lowest level since late 2014, leading companies to become more cautious about hiring new employees, IHS Markit says.
Exports were the weakest link again and many companies were forced to begin clearing old work backlogs to sustain output. “The key point here really is that the slowdown in manufacturing is now so severe that it almost surely will hit the official labour market data soon, which could change the political story, re fiscal policy, too. The chart shows that GDP growth rebounded at the start of the year, but incoming data suggest that the party ended abruptly in Q2, and the PMI now suggests a further slowdown in Q3, though it has an opportunity to recover in coming months,” says Claus Vistesen, chief Eurozone economist at Pantheon Macroeconomics.
Bank of England chief economist Andy Haldane sought to push back against market bets that the central bank’s next move will be an interest rate cut, saying he would resist lowering borrowing costs unless there was a sharp downturn.
Haldane contrasted the BoE’s stance with that of the U.S. Federal Reserve and the European Central Bank – both of which are expected to loosen policy – and stressed again that even a disruptive no-deal Brexit would not bring an automatic rate cut.
He acknowledged that business investment was “strikingly subdued” as companies struggled with Brexit uncertainty.
“My personal view though is that I would be very cautious about considering a monetary policy loosening, barring some sharp economic downturn,” he said at an event for local businesses in Scunthorpe, northern England.
BoE Governor Mark Carney and others have also deflected the idea that the Monetary Policy Committee is thinking of cutting rates while a Brexit deal remains possible.
They say the pricing of rate futures has been distorted by the risk of Britain leaving the EU without a transition deal on Oct. 31, creating a tension between their forecasts and market assumptions.
“Monetary policymakers are often cast as one-club golfers. In the current conjuncture, the problem is more that the MPC does not know which of two quite different fairways it should be aiming at,” Haldane said in his speech.
“With the economic road ahead potentially forking, the case for holding rates until the road becomes clearer is strong.”
Britain’s economy appears to have slowed sharply during the three months to June, reflecting a lull after businesses rushed to prepare for Britain’s original EU exit date of March 29.
Some economists think the country risks slipping into recession especially if there is a no-deal Brexit.
But Haldane highlighted robust consumer spending and the strong labour market and said Britain’s economy was running at full capacity.
Even after a no-deal Brexit – something incoming prime minister Boris Johnson has said is prepared to do if the EU refuses to renegotiate the withdrawal deal – the case for a rate cut would not be clear-cut, Haldane said.
Carney and other BoE policymakers have said the BoE is more likely to cut rates than raise them after a no-deal Brexit.
Carney sounded less positive about the economy than Haldane when he said this month that underlying growth was running below its potential and relying heavily on household spending.
“PRISONER OF PAST”
Haldane used his speech to warn that markets and the public had grown too accustomed to ultra-low interest rates, a marked contrast in tone from 2016, when he defended “sledgehammer” stimulus after Britain voted to leave the EU.
“It is important that monetary policy is not a prisoner of its past, that the monetary cavalry are not called at the first whiff of grapeshot, that a dependency culture around monetary policy is not allowed to develop,” Haldane said.
“Super-charging the supply side of the economy is what is now needed,” he added.
On Monday Britain’s National Institute of Economic and Social Research said a no-deal Brexit would hit the economy’s supply capacity and lower economic output by 5% relative to a softer Brexit.
Haldane said there was no better time to sort out deep-seated structural issues around education, training and transport links.
Johnson has said he wants to cut income taxes for higher earners as well as raise payroll tax thresholds, which would represent a major loosening of Britain’s fiscal policy.