BoE's Broadbent says Brexit may not mean low rates

Markets and analysts should not assume Brexit inevitably means lower interest rates, a Bank of England deputy governor has warned.

Ben Broadbent said judging the effect of Brexit on inflation and other economic variables had complicated the monetary policy committee's task in setting interest rates.

He said Brexit may have been partly responsible for markets underestimating the likelihood of interest rates rising before the BoE increased them at its November meeting. If that view persists markets are mistaken, he added.

In a speech at the London School of Economics, Broadbent said: "There’s been a persistent strain of opinion that EU withdrawal is something that necessarily means lower interest rates, or at least that it’s a reason to avoid putting them up.
If so, then I think the belief has been overdone."

This argument does not suggest rates will inevitably rise, Broadbent said. But the impact of Brexit is ambiguous because the effect on demand, supply and the exchange rate is unclear.

Inflation, which at 3% is a point higher than the BoE's target, is partly driven by the a gap between the expectations of UK consumers and currency markets about the effect of Brexit. Consumers are relaxed and have kept spending while markets foresee problems, pushing down the pound and increasing prices.

"If those expectations were to re-converge, from either end, inflationary pressure would diminish. If they diverge further the opposite would happen," Broadbent said.

The BoE has been struggling to communicate its intentions on interest rates amid uncertainty about the outlook for inflation and the effect of Brexit. After the BoE raised rates to 0.5% – the first increase for more than a decade – markets doubted rate-setters' resolve and pushed out expectations for the next increase.

The economic picture is complex with the potential for sudden unexpected changes to important economic variables, Broadbent said.

If disruption to supply chains caused by Brexit reduces productivity, firms would respond by increasing prices in the short term so that "reductions in supply can add to inflationary pressure even as they also lower aggregate GDP".

Broadbent added: "Some of those effects could come through faster than people often assume. If they do, then even the argument that Brexit lowers growth and therefore interest rates isn’t watertight."