Nobody knows what will happen. And that uncertainty makes it incredibly difficult to guess the future path of interest rates in the UK because the potential scenarios are many.
The base rate is currently 0.75%. It was hiked by the Bank of England in August from 0.5% because borrowing in the economy was strong and the labour market robust. But the economy is weakening again.
“Due to the ongoing Brexit negotiations and an unstable political picture, the degree of uncertainty in the economy is greater now than it has been for roughly a decade,” Nina Skero, head of macroeconomics at the Centre for Economics and Business Research (CEBR) consultancy, told Yahoo Finance UK.
“This means that the bands of uncertainty around economic forecasts, including those for interest rates, are also greater than usual. Furthermore, the anticipated GDP growth slowdown and the prospect of a sterling depreciation have made it more difficult to predict the direction of any change in interest rates.”
Leaving the European Union—or not, as the case may be, if there’s a second referendum with remain on the ballot—is such an all-encompassing event that it dominates the economy.
Businesses are delaying investments. Consumers are becoming less confident. GDP growth is weak. Little progress can be made until the Brexit question is finally resolved and everyone knows where they stand.
So when the moment finally comes, what happens next will determine how rate-setters on the Bank of England’s Monetary Policy Committee (MPC) respond.
The worst case Brexit scenario is that Britain crashes out of the EU with no deal and with insufficient preparation.
The economic shock of no deal—our trading relationship with the EU would grind to a halt, temporarily at least, despite accounting for about half of Britain’s trade—would likely send the value of sterling plummeting.
That would leave the Bank little choice but to hike rates sharply to shore up the pound and hold inflation down. Borrowing would become significantly more expensive for businesses and consumers.
Under the Bank’s model for a no-deal Brexit, the base rate jumps to 5.5%. If no-deal is mitigated by a transition arrangement, the base rate is anticipated to hit 1.75%.
Should there be a deal, however, under which Britain’s exit from the EU is managed, smooth, and any damage limited, it would give the Bank some breathing room.
Policymakers could take some time to assess the impact of the Brexit deal on the economy.
Although the base rate is near its historic low, there is room to cut it again to stimulate lending should the potential economic slowdown warrant it—so interest rates may fall after Brexit.
Likewise, the Bank could hold steady, keeping the rate at its current level for longer, maintaining the cheap lines of credit flowing into the economy for small businesses and consumers.
Or, if it believes the economy is robust enough to handle it even after Brexit, the Bank could continue with its current plan of gradual rises. It wants to bring the base rate back up to a more normal level after years of unprecedented lows in the aftermath of the 2008 financial crisis.
Source: Yahoo Finance UK