The Bank of England is underestimating the potential for difficult Brexit negotiations and its consequences for the UK economy as the bank shows a hawkish stance on rates and inflation prospects, experts have warned.
In today’s press conference following by the latest monetary policy update, the Bank forecasts assumed a “smooth” Brexit process, rising wage growth and rising productivity. It has warned rates might have to rise more quickly than markets expect on central forecast.
GDP growth is now forecast at 1.9 per cent for 2017 down from 2 per cent, while 2018 and 2019 have been forecast up to 1.7 per cent in 2018 (previously 1.6 per cent) and 1.8 per cent (previously 1.7 per cent).
As outlined in its inflation report, the central bank has also upped is projections for CPI in 2017, after inflation jumped above its target to 2.3 per cent in February and March.
Carney said the Article 50 process, which was triggered in March, has influenced the UK economy and inflation and it needs to be taken into account, but he says this “does not tie the hands of the monetary policy committee“.
Carney says: “We don’t know the shape of that [Brexit] agreement and so we have thought of different arrangements…What we have is an economy that will adjust to the negotiations.
He adds: “One of the consequences [of the Brexit negotiations] is that there is a bit of a drag in productivity in our forecasts but there is no sharp break or adjustments.”
A huge understatement
Aberdeen Asset Management chief economist Lucy O’Carroll says assuming Brexit will be smooth is “a huge understatement”.
She says: “The Bank of England is stuck between a rock and hard place. It has to base its forecasts on a view of the Brexit deal but, with so little to go on at present, it’s not an easy judgement.
“So far, the bank is sticking to its assumption that Brexit will be “smooth” – a deal will be reached and there will be a transition period from 2019. To say that is far from certain is a huge understatement.”
“Governor Carney acknowledges the risks, but the weight of uncertainty – and therefore frailty of the forecasts – does undermine the bank’s relatively positive message.”
Pioneer Investments European fixed income head Cosimo Marasciulo also warned about “smooth” Brexit predictions.
“Sterling has weakened a bit, probably based on the expectation that there would be two dissenters on unchanged monetary policy.
“We are relatively agnostic on the level and future direction of Sterling – we generally feel that it should be lower, given all the uncertainty the UK faces, but most investors are already short anyway so there may be little pressure to push it lower.”
Modest market reaction
Elsewhere, AXA Investment Managers senior economist David Page shares the skepticism shown by markets on the more hawkish appraisal by the BoE. Page also warns the assumption of a smooth transition may take some time to emerge, if the case, and could impact negatively on investment spending.
On today’s announcement, sterling fell by 0.5 per cent to the US dollar and 0.3 per cent to the euro, while 2-year and 10-year yields eased back modestly by around 1basis point to less than 0.12 per cent and 1.16 per cent respectively.
Page says: “We acknowledge a firmer global backdrop and can see this being more supportive to UK output growth. Yet the large uncertainty here is still the extent to which this translates into faster export growth. We expect exporters to use up existing capacity more quickly, but believe the confidence that they will add to capacity will be a function of Brexit uncertainty – as the BoE acknowledges is currently underway.
“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.”