Pound Drops as BoE Leaves Rates Unchanged

LONDON, BIOT - May 12, 2017 - PRLog -- The Bank of England (BoE) had its meeting on a Super Thursday and released its inflation report (http://www.bankofengland.co.uk/publications/minutes/Documents/mpc/mps/2017/mpsmay.pdf). Sterling fell against the US dollar to $1.28 after the BoE's release. It has hit a one week low against the dollar. The possibility of a rate hike is now a distant dream and the pound's prospect of reaching $1.30 is forever lost. As Dean Turner, economist at UBS Wealth Management said, "'Super Thursday' has become 'Average Thursday'."

The Bank cut its growth forecast from 2% to 1.9% and predicted that inflation will go as high as 2.8% this autumn. The Monetary Policy Committee (http://www.bankofengland.co.uk/monetarypolicy/Pages/overview.aspx) (MPC) of the BoE also voted to leave the interest rates at 0.25% and maintain its government bond purchases at £435bn and its corporate bond purchases at up to £10bn.

The BoE has warned that households' living standards will decline as Brexit will impact on the economy, pushing prices higher and stalling wage growth. While the interest rates remained at a record low of 0.25%, the Bank hinted that they might rise if inflation continues to increase.

The Bank's quarterly forecasts for economic growth this year were a bit higher (1.9%) than the year before (1.8%). But growth will slow next year to 1.7%.

Inflation was at the highest level in more than three years at 2.3%, due to higher oil prices and the pound's fall after the UK referendum vote, which increased the price of imported goods.

The Bank's MPC sets monetary policy to meet the 2% inflation target, so that economic growth and employment are maintained.

Mark Carney's press conference

The BoE governor Mark Carney held a press conference on Thursday afternoon at the BoE with deputy governor Ben Broadbent to present the Bank's quarterly report.

Carney said that the UK economy's future depends on households, businesses and financial markets' response to the Brexit negotiations. Already Brexit is affecting the economy, with wage growth slowing down, inflation increasing and consumer spending being squeezed. "Wages won't keep up with prices," Carney said, but he is hopeful that real wage growth will return later.

Wage growth has been weak for some time now, due to poor productivity and firms avoiding taking higher wage costs as Brexit uncertainty looms in the horizon. He said: "Uncertainty for companies about the outlook may also have made them unwilling to raise wages at a faster pace until they have more clarity about future costs and market access."

Since the UK economy relies on consumer spending, the pressure on household budgets will affect economic growth. But the Bank said that this would be counterbalanced by business investment and rising trade since cheap exports would be on demand.

This might appear too hopeful to economists who are expecting inflation to weaken economic activity and wage growth to diminish. Increasing input costs faced by businesses will also deter possibilities of investment, despite the BoE's more optimistic outlook.

Economic analysis

Economists agreed that the BoE forecasts depend on how the general elections and Brexit negotiations will unfold. For some, the Bank's growth predictions were too optimistic in terms of wage growth, stressing the volatile and uncertain political horizon.

Joshua Mahony, market analyst at IG, said:

"The chance of a rate rise during the long Brexit negotiations was always going to be slim, but Carney said that the speed of rate rises will be determined by how successful those negotiations are. The bank's upward revisions for inflation and downgrades to growth should be taken with a pinch of salt given the uncertainty provided by the impending election, oil prices and Brexit negotiations."

Howard Archer at IHS Markit:

"we maintain the view that the Bank of England is being too upbeat on the growth outlook with some pretty optimistic assumptions, particularly relating to the likely pick-up in wage growth. We also think Brexit uncertainties will hamper growth.

We maintain the view that the Bank of England is highly likely to keep interest rates at 0.25% through 2017 and 2018 - and very possibly beyond. In fact, we do not see the Bank of England edging interest rates up until 2020 given likely prolonged economic and political uncertainties centred on Brexit.

Similarly, David Page, Senior Economist at AXA Investment Managers said that the BoE might keep interests unchanged until 2019 and beyond: "While we recognise the risk that the MPC may tighten policy later in 2018 if Brexit negotiations are smooth over the next few years, we argue that in practice the materialisation of some downside risk is likely to leave the MPC keeping its policy rate on hold through the Brexit period and into 2019."

Brexit

As Carney repeated in the past, the BoE can't take the whole weight of the economy on its shoulders and that government officials should also coordinate their attempts to smooth the impact of Brexit. Carney emphasised that the Bank had adjusted its strategy in anticipation of Brexit, but added that monetary policy can't provide a panacea for the UK as it withdraws from the EU.

He said: "Monetary policy cannot prevent either the necessary real adjustments as the U.K. moves towards its new international trading arrangements or the weaker real income growth that's likely to accompany that adjustment over the next few years."

The Bank's forecasts depended also on the possibility of a "smooth" Brexit and he stressed that the Bank's policy can't be driven just by Brexit: "While Brexit will play an important role, other factors will also influence the outlook for the economy and inflation."

Moving forward, Carney said that monetary policy would be changed if economic development is "broadly consistent with its projection."

Brexit hangs heavy over the economic and political landscape, but at the moment, after Thursday's uncontroversial monetary policy meeting, the next stop would be the general elections, and who knows what might happen?