BoE Confident On UK Economy Even As Brexit Dispute Shakes Cabinet

BoE Confident On UK Economy Even As Brexit Dispute Shakes Cabinet

Investing.com  | Jul 11, 2018 09:02

by Darrell Delamaide

The Bank of England finds itself suddenly in the tricky situation of dealing with interest rate policy when the current government’s survival isn’t assured. BoE Governor Mark Carney sees a robust economy that likely needs a tap on the brakes with a rise in interest rates. But suddenly Prime Minister Theresa May’s government is in danger of unravelling and anything to slow down economic growth could increase that danger.

In fairness, Carney’s hawkish remarks last week came before the surprise resignation on Sunday of Britain’s chief Brexit negotiator, David Davis, followed on Monday by the even more dramatic departure of Foreign Secretary Boris Johnson, the former mayor of London and a leader of the “leave” faction in the Conservative Party.

Still, the pressures that led to the Brexit cabinet compromise on Friday, triggering the subsequent departures, have been building for some time. And European Union negotiators are still guarded about the impact the latest U.K. compromise plan will have on the single market

In spite of the uncertainties, Carney spoke approvingly of current growth and Britain’s prospects as exit from the EU approaches. “The current path is consistent with the [Monetary Policy Committee’s] current central projection, which assumes a relatively smooth transition to a Brexit that is the average of a range of outcomes,” he said on Thursday. “In this case, the committee’s reaction function will be more conventional, with the path of policy driven primarily by demand.”

In short, the MPC will almost surely hike interest rates at its August 2 meeting, as some 80 percent of surveyed market participants believe. The likelihood was bolstered further by GDP figures out this week showing growth of 0.3 percent in May, up from 0.2 percent in April.

The numbers jibe with Carney’s earlier analysis. “Domestically, the incoming data have given me greater confidence that the softness of UK activity in the first quarter was largely due to the weather, not the economic climate,” he said in his speech last week.

Looking back on the June MPC meeting, the main takeaway was that chief economist Andrew Haldane dissented from the majority and called for a rate hike right away. He and two others wanted rates to rise to 0.75% but the majority kept rates unchanged at 0.5%. Haldane's turning hawkish makes a rate rise in August more likely.

The BoE will also feel constrained by its previous reversal in May. After it had signaled a rate hike, weakness of incoming data convinced policy-makers to back off. That concern has dissipated with the new data, but the prior U-turn damaged the Bank’s credibility.

Monetary policy makers in Britain, like those in the US, are bedeviled by the failure of the Phillips curve to maintain its historical accuracy in predicting inflation when hiring picks up. As unemployment has fallen to 4.2% in Britain, there should be some signs of inflationary pressure. But there is, in fact, little sign of inflation as total pay increases in the three months to April were 2.5% higher on the year, down from 2.6% in March and 2.8% in February.

Some argue wage inflation has been delayed and will kick in any day. Others think there is more slack in the labour market than is evident from the data, with people still underemployed or not hopeful enough to join the labour force.

GBP vs EUR and USD 300 Minute Chart

Markets showed little reaction to the government crisis, though sterling was down against both the US dollar and the euro. Short of a full-fledged leadership challenge, however, further losses seem unlikely. May moved quickly and decisively to name replacements for Davis and Johnson.

But the reasons for their resignations aren’t going to go away. Both felt May’s proposal for the EU made too many concessions and subjected Britain to many of the EU’s rules and regulations in violation of the referendum’s vote to get out from under Brussels’ yoke. Investors, on the other hand, could see her compromises as more realistic and better for the economy, although the EU still has to give the proposal the green light.

Johnson’s departure complicates May’s task in getting parliamentary approval for any accord she does come up with. Also, Johnson could potentially challenge her for leadership of the party, or trigger new elections with unpredictable results. May, however, has proved resilient and wriggled out of other tight spots. For now, markets appear content to wait and see.

Investing.com

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