Bank of England leaves rates and QE unchanged, warns of global Brexit risk

The Bank of England has left interest rates and asset purchases unchanged and warned if the UK voted to leave the EU next week it posed a great risk to not only the domestic economy but also to world financial stability.

The BoE Monetary Policy Committee voted unanimously to leave bank rates unchanged at 0.50% and its asset purchase target at £375bn, as widely expected.

On its assumption that the UK will remain in the EU, which increasingly appears to be less secure given recent poll results, the MPC's core view is that the next move for interest rates will be upward.

But, although Governor Mark Carney has been criticised for weighing into the Brexit debate, the committee warned that a Brexit vote "could lead to a materially lower path for growth and a notably higher path for inflation" than set out in May’s Inflation Report, and so kept its policy options open post-referendum, implying that interest rates could rise or fall depending on the magnitude of the shocks to demand, potential supply and sterling.

Ahead of next Thursday's referendum, the MPC minutes noted an ever wider range of financial assets were being jostled by worries about a potential Leave vote and that increased uncertainty has led to increased delays in major corporate decisions regarding business investment, commercial real estate transactions and M&A activity.

"On the evidence of the recent behaviour of the foreign exchange market, it appears increasingly likely that, were the UK to vote to leave the EU, sterling’s exchange rate would fall further, perhaps sharply," read a statement summing up the minutes of the MPC's meeting.

"This would be consistent with changes to the fundamentals underpinning the exchange rate, including worsening terms of trade, lower productivity, and higher risk premia."

Furthermore, noting that domestic interest rates and bank funding costs appear have already been materially influenced by opinion polls about the referendum, the Bank also said this was becoming seen in non-sterling assets as risk sentiment wanes globally due to increasing uncertainty ahead of the vote.

"The outcome of the referendum continues to be the largest immediate risk facing UK financial markets, and possibly also global financial markets," the minutes thundered.

Carney criticism

Reports from the BBC earlier revealed Carney had sent an angry response to senior figures in the Vote Leave campaign after they attempted to warn him off from making "any public comment" in the run up to the referendum.

The Canadian argued that he and the rest of the MPC were not making their private feelings known but all of their public comments regarding issues the referendum were "limited to factors that affect the Bank's statutory responsibilities and have been entirely consistent with our remits".

Carney said that Mr Jenkin's letter "demonstrates a fundamental misunderstanding of central bank independence" and that the Bank has "a duty" to report its "evidence-based judgements" to Parliament and the public.

As the path of the economy is already being affected by even anticipation of the vote results, the MPC seemingly felt only appropriate for its minutes to again highlight the dangers it perceives.

Indeed, it said, with the change in economic condition compared those noted in its May inflation report, the combination of movements in demand, supply and the exchange rate could lead to a "materially lower path for growth and a notably higher path for inflation".

"In those circumstances, the MPC would face a trade-off between stabilising inflation on the one hand and output and employment on the other. The implications for the direction of monetary policy would depend on the relative magnitudes of the demand, supply and exchange rate effects."

Reaction

The minutes were essentially a carbon copy of May's MPC meeting, said Sam Tombs at Pantheon Macroeconomics.

"The Committee continues to judge that most of the recent economic slowdown, indicated by weak activity surveys and falling spending on big-ticket items, is due to Brexit risk," he said.

"Even if the referendum was not being held, however, it is doubtful that the Committee would be on the brink of raising interest rates, given the current weakness of CPI inflation, just 0.3% in May. Inflation, however, will rebound sharply around the turn of the year as commodity and import prices swing from depressing it to boosting it. The MPC also noted today that unemployment had fallen slightly faster, and wage growth accelerated slightly more, than it had expected, implying that it has less time to keep rates on hold than it thought previously."

Howard Archer at IHS Global Insight, agreed most was entirely as expected, given latest economic developments and that the outlook for the UK economy is in large part hostage to the result of the referendum.

With Tuesday's data on consumer price inflation showing it remained at a depressed 0.3% in May, with earnings growth still below the level the Bank considers necessary to get consumer price inflation back up to its 2.0% target in the medium term, Archer said the Bank was "clearly some way" from raising interest rates.

Should the UK vote to leave the EU, Archer believes it is most likely that the Bank would sooner or later cut interest rates to 0.25% from 0.50% and could also very well resuscitate quantitative easing.

"We suspect that growth will become the main concern within the BoE and the MPC will be prepared to look through any near-term spike in inflation from a weakened pound. The BoE will likely take the view that the weakened growth outlook means it will be harder to hit the 2.0% inflation target in two years' time.

"Of course, the Bank of England’s position may well be made even harder if there is a sharp flight of capital from the UK after an EU exit vote, thereby exerting pressure for higher interest rates to attract the inward investment that is needed to finance the large current account deficit."