The Bank of England says the chasm between financial services and UK households over their expectations for Brexit is impacting policy making by hitting the exchange rate.
Deputy governor Ben Broadbent has also played down the assumption the UK’s decision to leave the European Union automatically results in lower rates.
Brexit pessimism among financial services has been highlighted in the reaction of stock and currency markets, while UK household spending points to a more optimistic outlook, Broadbent told the London School of Economics in a speech on Wednesday.
Broadbent says it is not yet clear which group is right or wrong.
Demand, supply and the exchange rate all played into post-Brexit monetary policy decision making, he said. “There are feasible combinations of the three that might require looser policy, others that lead to tighter policy.”
A convergence of views would lead to weaker inflationary pressure, Broadbent said.
“If the currency market had been as sanguine as households sterling would not have fallen as far, if at all, and inflation of import prices and the aggregate CPI would not have risen to the same extent,” he explained.
“If, conversely, consumers shared the currency market’s more pessimistic view of the future, domestic demand would have been weaker and inflationary pressure would again have been lower.”
He says it is unpredictable whether views will diverge or converge and hence what that means for monetary policy.
Broadbent made the comments in a speech stressing that Brexit does not necessarily result in lower rates and that the market had been underestimating the chance of hikes since the referendum.
He argued markets had also taken their eye off the larger picture, noting that the UK economy had been sustained by improving global growth in the period since Brexit and would falter if that changed.
Brexit could be one of the rare events to cause a short-term hit to productivity because the UK might have to quickly adapt to trade barriers, Broadbent warned.
The UK would not transition seamlessly from directing resources away from sectors with large exports to the EU to goods and services that have traditionally been imported from the Continent, the deputy governor said.
“A plant used to produce a particular car part, as part of an integrated European supply chain, cannot suddenly be converted into one that makes a complex German machine tool. A field currently producing barley, sold into the European market, can’t easily or as fruitfully be replanted with olive trees.”
Forty per cent of UK firms who currently use EU suppliers are actively looking for domestic alternatives, while 63 per cent of EU businesses are looking to move away from UK suppliers, he said.