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Carney's 'Brexit' headache worsens with rate outlook schism
[NEW YORK] Mark Carney could face a challenge in just over two months, regardless of whether Britons choose to stay in or quit the European Union.
While the Bank of England governor has signaled a slow tightening path, and investors see no rate increase for years, a vote to stay in the EU on June 23 potentially creates a whole new backdrop. With 'Brexit' risk removed, markets could pull in bets for a hike, generating a new communication hurdle for the Monetary Policy Committee, which holds its monthly meeting this week.
With economic growth relatively consistent - if not stellar - and inflation forecast to accelerate, some economists predict a win for the "remain" campaign could enable a rate increase as soon as this year. The market's pessimism about the prospect for a near-term hike is mirrored by international caution, with the European Central Bank adding stimulus and the Federal Reserve agreeing a go-slow strategy for its tightening.
"Fundamentally the UK economy is in good shape," said James Knightley, an economist at ING Bank NV. "'If it wasn't for the Brexit vote, I'd be much more optimistic. The labor market is incredibly tight, confidence is high, house prices are moving higher as well."
The BOE's nine-member MPC will probably vote unanimously to keep the benchmark interest rate at a record-low 0.5 per cent on Thursday as uncertainty generated by the referendum supports the case against action. The decision will be released at noon, alongside a policy statement and a record of members' votes.
Separate data this week will show inflation ticked up to 0.4 per cent in March from 0.3 per cent in February, according to economists surveyed by Bloomberg. That means that rate will have been below the central bank's 2 per cent goal for 27 months. In their latest projections, BOE officials forecast it will stay below 1 per cent until the turn of the year before climbing back to target at the start of 2018.
Inflation Increase Still, there are signs that inflation is now past its trough. Policy makers may offer an analysis of how the pound's recent decline will affect the rate of price growth and an assessment of a rebound in oil costs. Sterling has fallen about 11 per cent since the start of December on a trade-weighted basis, making imports more expensive.
The pound strengthened against the dollar and was 0.8 per cent higher at US$1.4238 as of 11:40 am London time.
The domestic factors that have kept a lid on inflation may also be fading. Wage growth excluding bonuses accelerated to 2.2 per cent in the three months through January, while there may be an additional upside from the increase in the UK's national minimum wage.
"We expect to see more of a pass-through from the recent fall in sterling," said David Hooker, a money manager at Insight Investment Management. Also, "there are tentative signs that wage pressures have built and obviously they've seen the introduction of the minimum living wage which occurred very recently. This all suggests that domestically, at least, inflationary pressures are building."
In that scenario, if Britons vote to remain in the EU, attention could return quickly to when the BOE will start raising rates. With wage and unit labor cost growth gradually increasing as economic slack is eliminated, that could be as early as the end of the year, according to James Rossiter, an economist at TD Securities in London.
"If this keeps up through the year, that's definitely laying the cards for the BOE to ultimately start lifting rates on inflation fears," he said. "November is the first prime opportunity but it might not be what they end up going with." Economists at Bloomberg Intelligence calculated that removing the risk of a 'Brexit' would bring forward bets on an increase to the first quarter of 2018, seven quarters earlier than the market currently anticipates. In the case of an exit, a move higher isn't seen until well after 2020.
Setting the referendum aside, the international backdrop may yet darken further, a concern underlined by the BOE in March. And while economists see a rate increase much earlier than investors - who are even pricing in some chance of lower rates - a Bloomberg survey shows they've still pushed their forecasts back to the first quarter of next year. That compares with the fourth quarter of 2016 previously.
There are also signs that UK growth is cooling. Industrial production unexpectedly declined in February, and the National Institute for Social and Economic research estimates the economy grew the slowest more than three years in the first quarter.
"The MPC are unlikely to regard near-term weakness in the economy as a reason to loosen policy, but will wait to see how things look after the EU referendum," said Michael Saunders, an economist at Citigroup Inc. "We continue to believe that the next rate move is probably - eventually - up rather than down, in both a Brexit scenario and our base case of continued EU membership."