Last week’s November meeting of the Bank of England’s Monetary Policy Committee (MPC) concluded in line with market expectations for no changes to policy.
The decision to maintain its current policy stance was unanimous.
Back in August, following the Brexit referendum, the MPC introduced a raft of policy-easing measures in response to the potential headwinds for the economy arising from the referendum vote in favour of leaving the EU.
The measures included cutting interest rates by 25 basis points to 0.25% and restarting its QE asset purchase programme. Since then, the BoE acknowledged that the performance of the UK economy has been “materially better than expected”.
The UK economy grew by 0.5% in the third quarter, above market expectations for a 0.3% rise. In year-on-year terms, the pace growth increased to 2.3%.
In the near-term, the economy could be in something of a ‘sweet spot’, benefiting from the impact of looser monetary policy and the weaker sterling before negative impacts such as rising inflation take hold.
However, the UK economy is facing into a period of heightened uncertainty.
Indeed, Bank of England governor Mark Carney commented that the High Court ruling regarding the triggering of Article 50 was “an example of the uncertainty that will characterise” the Brexit process.
The exit process and associated uncertainty is likely to weigh on consumer spending, the key driver of UK growth. Business investment could also be adversely impacted by the Brexit vote.
The labour market may also suffer, with employers potentially holding off on hiring new workers if they expect weak growth and if there is a lack of clarity over future access to the Single Market.
Thus, the impact of the referendum vote is still likely to be negative overall, leading to quite a more subdued pace of growth in the next couple of years.
The negotiating process to decide on the UK’s EU exit terms and agree a new trading arrangement could drag on for quite some time.
The outcome of these talks will ultimately determine the long-run implications of Brexit for the economy.
The Bank of England now expects that growth in the near-term will not weaken as much as previously forecast, aided by the resilience in household spending and sentiment.
However, it envisages growth will be somewhat weaker than previously anticipated in the medium-term.
This is reflected in the latest set of GDP forecasts from the Bank of England with upgrades to its 2016 (to 2.2% from 2.0%) and 2017 (to 1.4% from 0.8%) growth projections, while the 2018 figure has been revised downwards (to 1.5% from 1.8%).
On the inflation front, the MPC said that CPI inflation is now expected to be higher throughout the three year forecast period than at the time of its August Inflation Report, mainly as a result of the deprecation of sterling.
The updated projections have inflation peaking at around 2.8% by mid-2018, before gradually falling back over 2019, but it is not expected to return to its 2% target until 2020.
The bank is of the view that sterling’s impact on inflation would “ultimately prove temporary”.
Therefore, it believes that attempting to deal with higher inflation by tightening monetary policy could prove “excessively costly”.
However, the Bank of England also emphasised that there were limits to the extent to which above-target inflation could be tolerated and that it would monitor closely the evolution of inflation expectations.
Against this backdrop, all MPC members agreed that the guidance it had previously issued regarding the likelihood of a further cut in Bank Rate had expired and that monetary policy could respond, “in either direction” to the evolution of the economy, the exchange rate and inflation.
In recent weeks, futures markets had already adjusted to the better-than-expected economic data by no longer pricing in further easing from the Bank.
John Fahey is senior economist at AIB
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