BoE leaves policy unchanged, increasingly highlights Brexit risks – ING

James Knightley, Research Analyst at ING, notes that the Bank of England has left monetary policy unchanged (Bank Rate 0.5%, QE at £375bn) with the vote coming in 9-0 for both.

Key Quotes

“The BoE has also released its quarterly Inflation Report, which contains updated forecasts. They have acknowledged the recent softening in the UK activity data and lowered its 2016 GDP growth forecast to 2% from 2.2% versus ING’s own prediction of 1.8%. However, they have actually slightly nudged up the prediction for the central rate of CPI in 2 years’ time based on market interest rates to 2.07% from 2.05%.

They obviously highlight the uncertainty that the Brexit referendum is generating, suggesting that there are already signs that it is weighing on activity. Should the UK actually vote to leave then the BoE warns that it would raise risk premia and hurt capital inflows, it may also lead to the pound depreciating further, possibly “sharply” which in combination would lead to inflation moving higher and a lead to a weaker outlook for growth. Conversely, growth would probably pick-up if the UK votes to remain.

We agree that if the UK does vote to remain a member of the EU then the UK economy will bounce back. However, the slowdown in UK economic activity has been more significant than we had thought likely and it could therefore take longer for the recovery in investment and hiring to come through. The referendum is right at the end of the second quarter and it is unlikely that businesses would suddenly start to spend immediately at the beginning of 3Q. As such we are thinking that growth is more likely to recover strongly in 4Q16/1Q17, which dramatically reduces the likelihood of a 4Q rate hike from the Bank of England.

Should the UK vote to leave the EU then we see significant downside risks to the economy as businesses and households retrench and financial market volatility spikes. Sterling would likely collapse and interest rates would probably be cut as the Bank of England tries to shore-up confidence. Such an outcome would likely have global ramifications with the euro probably weakening in response. The Federal Reserve could also delay its tightening cycle as the dollar rallies on safe haven flows, which would tighten US financial conditions.”