BoE Preview: Carney Set to Combat Brexit Agony as Inflation Seen Picking Up

There is no doubt that BoE policymakers will keep the policy unchanged in May, despite signs that UK economic growth has been notably suppressed as Brexit concerns continue to weigh on business sentiment.

London – As the UK is heading toward the EU referendum scheduled for June 23, the fresh macroeconomic forecast from the Bank of England (BoE) is likely to turn into the “No Brexit Fear” event, with the medium-term outlook for inflation potentially revised upward for the first time under Governor Mark Carney’s command at the Bank. The short-term GDP outlook is expected to be revised down, mostly on the back of the ongoing nervousness and economic and political uncertainty ahead of the EU plebiscite.

It is a given that Carney will avoid any political interference or comments related to the referendum. Nevertheless, the vote in June and its outcome represent the biggest risk event this year, whether to the upside or downside.

While the outlook for economic growth is expected to be scaled down with Brexit being the major demon of a potential slowdown, inflation might be revised upwards. The oil price jump of more than 50% off its cyclical bottom in the middle of February, and sterling’s depreciation, are seen as the major upward drivers of inflation.

Looking at sterling from a broader perspective, the currency has lost some 6.2% since the beginning of this year and it is even lower when compared to last Inflation Report from February this year. This is going to feed into higher import prices in the year to come, even with a large degree of flexibility that floating exchange rates provide for economic entities.

All three Markit/CIPS PMI April surveys showed either inflationary pressures picking up, or deflationary pressures easing. The services PMI survey revealed, mainly due to an introduction of the National Living Wage, that the inflation rate sped up to a 27-month high in April, “with cost pressures also linked by firms to rising fuel prices and the impact of the weaker pound”.

The estimates of the annual rate of UK CPI for this year range between 0.8% up to 1.8%.

The BoE, the guardian of price and financial stability, plans additional liquidity measures a week ahead of the EU referendum as part of the Bank’s regular Indexed Long-Term Repo (ILTR) operations. The BoE will also continue to offer dollar liquidity in the weeks around the referendum.

The immediate effect of Britons opting to leave the EU is a broad-based weakening of sterling. Analysts from NIESR forecast sterling weakening up to 20% in the days following a Brexit outcome, which would be a major inflationary impulse for the coming quarters. This could also keep the BoE cautious on rate cuts.

NIESR sees inflation rising up to 2.2% in 2017 in case the UK remains in the EU. In its pessimistic view of Brexit, inflation is seen surging to 3.8% during the same period, mostly on the back of a sharp depreciation in sterling.

Since the slowdown in UK economic growth may only be temporary, mostly depressed by Brexit fears, the BoE is expected to keep its policy unchanged in May, with all nine rate-setters expected to unanimously vote to keep rates on hold.

Source: World Business press


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