BoE says Brexit having greater than anticipated effects on UK

Rate-setters at the Old Lady of Threadneedle Street chose to keep a steady hand on the tiller on Thursday, even as they cut their near-term economic forecasts for the UK in the face of slower growth abroad and the stiffer-than-anticipated headwinds from Brexit.

Nevertheless, they sounded a relatively confident, or even 'hawkish', note on policy - as did several analysts - when it came to the medium-term outlook, keeping their forecast for UK GDP growth over the four quarters ending in March 2019 at 1.7%.

They also said that "were the economy to develop broadly in line with its Inflation Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent."

Indeed, policymakers at the Bank of England appeared to still see scope for one 25 basis point hike in Bank Rate over the course of 2019, although it was now a close call.

Significantly, the conditioning assumptions underlying the Monetary Policy Committee's deliberations showed that the MPC now saw "excess supply" in the economy worth a quarter of a percentage point of gross domestic product for quarter one of 2020, instead of the quarter point of excess demand they had previously penciled-in.

For the same quarter of 2022 on the other hand, they now expected "excess demand" worth three quarters of a percentage point of GDP. At the time of the November Inflation Report, Bank had expected half a percentage point of "excess demand" by quarter four of 2021.

That appeared to indicate that the Bank of England's policy bias was now more dovish over the short-term, but the opposite when looking out to the end of its three-year policy horizon.

MPC members' mean forecast for the pace of UK GDP growth in 2019 was 1.2%, versus 1.7% in November, whereas that for CPI was 2.0%, which was down from 2.1%.

Faced with the above, the MPC unanimously decided to keep Bank Rate at 0.75%, to maintain the stock of UK government bond purchases at £435.0bn and that of debt issued by investment-quality non-financial firms at £10.0bn.

Regarding the external environment, the BoE said the weaker pace of expansion was set to drag on British imports, although more accomodative monetary policies "in all major economic areas" was already expected to prop up activity.

On the UK, the BoE added that "Brexit uncertainties [...] could lead to greater-than-usual short-term volatility in UK data, which may therefore provide less of a signal about the medium-term outlook.

"Heightened uncertainty and elevated bank funding costs are assumed to subside over time, as greater clarity on future trading arrangements is assumed to emerge."

Significantly, policymakers reiterated that their forecasts assumed a "smooth" adjustment to the "average of a range of possible outcomes for the UK's eventual trading relationship with the European Union and the gently rising path of Bank Rate implied by market yields."

"The monetary policy response to Brexit, whatever form it takes, will not be automatic and could be in either direction," the BoE added.

In an initial reaction, as of 1215 GMT the pound was trading 0.47% lower against the US dollar to 1.2874 versus the 1.28703 where it was at just before the policy announcement.

Meanwhile, the yield on the benchmark 10-year Gilt was down by six basis points to 1.16%.

SOME ANALYSTS REACT

Commenting on Thursday's MPC decision, Samuel Tombs, chief UK economist at Pantheon Macroeconomics, said: "The MPC has not chucked in the towel on plans for further monetary tightening, but the two rate hikes that we anticipated this year now look out of reach.

"All of the MPC’s forecasts have to be taken with a hefty pinch of salt, given that they remain "conditioned on a smooth adjustment to the average of a range of possible outcomes for the UK’s eventual trading relationship with the EU.”

"We think this assumption will prove to be too cautious and that Brexit ultimately will be very soft, paving the way for a recovery in business investment that will create more room for the MPC to hike Bank Rate over the coming years. As a result, we maintain our forecast for two increases in Bank Rate in 2020, but now see just one hike this year, most likely in August."

"Ahead of 29 March, the market is of course hoping for the best outcome. The upside seems limited to $1.3100, while the downside is $1.10 and lower," chimed-in Invstr boss Kerim Derhalli.

"This sets up an asymmetric trade – where traders have a good chance of positive outcomes – for the pound over the next few weeks and months."

Echoing that sentiment, strategists at Bank of America-Merrill Lynch added: "Our base case assumption remains that a Brexit deal will be done eventually, allowing a smooth Brexit to transition, and some bounceback in the data and BoE sentiment. But our conviction is low, especially on timing.

"So we continue to view the main risk being, as we argued before (note), that the BoE does not hike at all this year."

Fabrice Montagné and Sreekala Kochugovindan at Barclays Research added: "By maintaining its long held view of excess demand growing over the forecast horizon and inflation sticky above target, the Bank essentially maintained its generally hawkish stance, albeit making its point in a less forceful way at this stage given short-term risks to the global economy and Brexit."

-- More to follow --