Bank of England Holds Rate at Record Low and Strengthens Brexit Warning

The Bank of England cut its growth forecasts and issued its strongest warning yet that a vote to leave the European Union would hurt the economy.

With just six weeks to go until Britains referendum, the nine-member Monetary Policy Committee, led by Governor Mark Carney, said there were more signs it was weighing on growth and clouding the outlook. Officials unanimously agreed to maintain their benchmark rate at a record-low 0.5 percent, saying inflation remains subdued.

A vote to leave the EU could lead to a materially lower path for growth and a notably higher path for inflation, the central bank said in its quarterly Inflation Report. Sterling is also likely to depreciate further, perhaps sharply.

The BOE provided a detailed assessment of the risks surrounding a Brexit, saying it could lead to a prolonged period of uncertainty, hurt capital inflows, raise risk premia, increase bank funding costs and threaten financial stability.

The report marks the central banks most detailed assessment of the potential effects of a Brexit, and may leave officials open to fresh criticism that they support the Remain camp. Carney has maintained he is neutral in the debate and that it would be political of him to suppress the central banks analysis of the risks.

Less Informative

While policy makers lowered the growth outlook, their inflation projections were little changed, with price growth seen slightly above the 2 percent target in two years time. The estimates were based on an assumption that Britain remains in the EU and included an adjusted path for the pound, which stripped out roughly half of sterlings 9 percent decline since November, on the basis it is referendum-related.

The pound strengthened after the report was released and as up 0.2 percent at $1.4476 as of 12:16 p.m. London time. It appreciated 0.4 percent to 78.76 pence per euro.

The vote makes macroeconomic and financial market indicators less informative than usual, Carney wrote in a letter to Chancellor of the Exchequer George Osborne released alongside the report. In advance of the referendum, the MPC has indicated that it will react more cautiously to incoming data than would normally be the case.

Officials said that the uncertainty would lead to a further weakening and cut their second-quarter gross domestic product forecast to 0.3 percent from 0.5 percent. While growth would probably rebound in the event of a vote to remain in the EU, the effect of existing uncertainty could persist for some time, Carney said.

Policy Tradeoff

In the event of a Brexit, policy makers said they would face a trade off between stabilizing prices and maintaining demand. Heightened uncertainty could also test the capacity of core funding markets at a time when liquidity had been fragile, the bank said.

Officials also cited the U.K.s record current account deficit as a potential vulnerability.
Increased perceptions that the outcome of the referendum could lead to a weaker outlook for U.K. national income may call in to question the ability to maintain the current large-scale of capital inflows, the MPC said. An abrupt decline in capital inflows could pose a major financing difficulty for the U.K.

Policy makers cut their 2016 gross domestic product forecast to 2 percent from a previous prediction of 2.2 percent. For 2017, they reduced the projection to 2.3 percent from 2.4 percent, while 2018 was lowered to 2.3 percent from 2.5 percent.

Rate Path

The inflation outlook signaled the MPC remains relaxed about the need for higher rates, with the report saying domestic cost pressures and core inflation remain subdued. Consumer price growth, which was 0.4 percent in March, is projected to rise to 2.1 percent in the second quarter of 2018, just above the central banks 2 percent target. It will reach 2.2 percent a year later, the forecasts showed.

Projections for wage growth were little changed. The BOEs forecasts were based on 25 basis-point rate increase by the second quarter of 2019, though the central bank said higher credit spreads had largely offset the effect of the lower path compared with February.

Source: http://www.bloomberg.com/

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