Central banks around the world are gearing up for a fresh round of monetary stimulus — but the Bank of England confirmed on Thursday that it had no plans to join the global rush to cut interest rates.
Although it shares the gloomy view of US and European policymakers on the weakening outlook for global growth, the BoE’s Monetary Policy Committee voted unanimously to leave UK rates on hold.
While the UK economy is clearly suffering from the strains of acute Brexit uncertainty — and in particular the growing prospect of the UK crashing out of the EU without a deal — British policymakers maintain interest rates will still need to rise, once those uncertainties are resolved.
Coming a day after the US Federal Reserve’s first rate cut in a decade, and with the European Central Bank poised to launch fresh stimulus in the autumn, the contrast could not be clearer.
In normal circumstances, the divergence in central banks’ outlook for interest rates would swiftly show up in markets. But on Thursday the BoE’s message had little discernible effect on currency markets with sterling ending the day close to 30-month lows.
“Markets have been deaf to the MPC’s message of late and this is unlikely to change,” said Andrew Goodwin, at the consultancy Oxford Economics.
The reason is simple: investors are fixated on the increasing risks of a no-deal Brexit, but the BoE’s forecasts do not reflect this risk, and the MPC has not given a collective view on what it would do if the worst-case outcome did materialise.
Mark Carney, the BoE governor, defended this position on Thursday, saying that the central bank had taken action to make sure the core of the financial system could survive a no-deal shock, but that the government’s policy was to pursue a deal, and any change in that assumption was for politicians.
He also argued the MPC could not give useful guidance on how it would respond to a chaotic Brexit because it would be a shock to demand and supply — in which it might not be possible to cut interest rates without fuelling inflation.
But economists accused the BoE of ducking the most pressing question facing policymakers.
“It seems to me that government policy is not to leave with a deal — it’s to leave somehow. The BoE ought to provide scenarios to reflect that,” said Jagjit Chadha, director of the National Institute for Economic and Social Research, while Peter Schaffrik at RBC Capital Markets said Mr Carney had been “left sitting on the fence . . . defending a Brexit assumption that looks increasingly unrealistic”.
Paul Hollingsworth, economist at BNP Paribas, said that since several MPC members had already signalled they would be more likely to cut interest rates after a no-deal outcome than to increase, the lack of guidance “suggests there is no consensus on the committee about how it should respond”.
The BoE’s central forecasts, premised on a smooth Brexit that would boost the economy, show inflation overshooting its target by a significant margin, rising to 2.4 per cent on a three-year horizon. The BoE has sharply cut its forecasts for growth this year and next, to 1.3 per cent in each year, saying that underlying growth has slowed below its potential rate, but it now believes the rebound that would follow a Brexit deal will be even stronger than its May forecasts suggested.
The trouble is that these forecasts are of little practical use, because they are built on current asset prices. Investors, who see a rising chance of a no-deal Brexit, have been selling the pound and betting that the BoE will cut interest rates by the end of the year. These market moves result in a higher forecast for inflation.
The BoE has tried to deal with the problem by setting out alternative projections, showing what would happen to inflation if a Brexit deal led markets to take a more optimistic view of the economic outlook. It said that although growth and inflation would be lower in these scenarios, there would still be significant excess demand, fuelling inflation, after any orderly form of Brexit deal. It therefore thinks interest rates will need to rise, “assuming a smooth Brexit and some recovery in global growth”.
Some economists said that despite this relatively hawkish language, the BoE in fact appeared to have become more dovish since it last set out forecasts in May. Kallum Pickering, at Berenberg, said the conditions for higher rates — a smooth Brexit and a stronger global economy — were “two big bets”.
Yael Selfin, chief economist at KPMG, and Paul Dales, of consultancy Capital Economics, both noted that inflation in fact remained close to target in the BoE’s alternative scenarios, even though they were built on a market path in which interest rates would remain on hold or rise only once.
Mr Dale added that the MPC had clearly become “more concerned about the outlook for both the global and the domestic economies even if there’s a Brexit deal”.
