Britain quitting the EU will likely see inflation spike, hit consumers in pocket

Britain voting to quit the European Union this month will likely push UK inflation much higher -- hitting consumers in the pocket and possibly even forcing Bank of England to hike interest rates sooner than expected.

UK consumer-price index data for May showed inflation flat at 0.3% on an annual basis, but short of forecasts for a 0.4% rise. All remaining equal, many economists see inflation gradually rising through second-half 2016, perhaps towards 1.0% in fourth quarter of 2016 and 2.0% in late 2017.

But a string of recent opinion polls suggest radical change is imminent. The two most recent -- Guardian/ICM and YouGov -- put the Brexit campaign to leave the EU ahead of that for Bremain. Many in the market see this outcome as increasingly likely and are already factoring into their inflationary models.

In the event of a Brexit outcome on 23 June, said Howard Archer, chief UK and European economist at IHS Global Insight, the UK's inflation and growth outlook will almost certainly shift.

"There are very good reasons to believe that a sharp fall in sterling will occur with very significant inflationary implications," Archer said.

"At the same time though, there is a very real risk of markedly weakened economic activity, particularly resulting from heightened uncertainty among businesses and consumers, leading to less investment, higher unemployment and reduced consumer spending."

Both Archer and assistant professor Daniele Bianchi, of Warwick Business School, along with multiple other market experts, saw this as having implications for BoE monetary policy.

"In the short-term this could substantially increase inflation from imported goods, which could outweigh the positive effects of more competitive exports as the UK currently runs a negative gap in the balance of trade against Europe," Bianchi said.

"A steep rise in inflation could force the Bank of England to raise interest rates potentially affecting mortgages and ultimately the housing market," Bianchi, an expert in empirical asset pricing and commodity markets, said.

Archer continued: "At the same time though, there is a very real risk of markedly weakened economic activity, particularly resulting from heightened uncertainty among businesses and consumers, leading to less investment, higher unemployment and reduced consumer spending. These have diverse implications for monetary policy."

Markets are expecting BoE to hold its benchmark interest rate at 0.5% on Thursday, and retain quantitative easing at £375bn. All eyes will be on its accompanying statement, and so too on rates fixtures for the US Federal Reserve and Bank of Japan given volatile currency and commodity markets.

Most agree a Brexit outcome will see sterling slide against both the dollar and euro. Bianchi picks that from Monday evening's levels it could slump 15% on the dollar and 10% on the euro (GBPEUR), to roughly $1.21 and €1.13 respectively. Post a Brexit vote, Rabobank puts the cable potentially around $1.26 area, and EURGBP at 0.86.

At 13:06 BST, sterling was down 0.98% to $1.4130 and down 0.36% to €1.2588. Safe-haven gold was steady at $1286.2 an ounce, while UK 10-year gilt yields were lower 7 basis points to 1.14%. All reflected the Brexit nerves pulsing through the markets and a general investor flight towards perceived safety.

Paul Holingsworth, UK economist at Capital Economics, contended that a Brexit-induced dive in sterling would place "significant upward pressure on inflation further ahead." He argued that this could be offset to some extent if the UK economy tanked sharply.

According to the latest YouGov poll, published in The Times on Tuesday, support for Brexit jumped by three percentage points to 46% over the latest week, while backing for ‘Remain’ lost another three percentage points to 39%.

A poll from Guardian/ICM, released late Monday, showed the Leave camp enjoyed a 53%-47% advantage, compared with a 52%-48% split reported two weeks ago.