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23 Oct 2018 | By Richard Buxton

A closing window of opportunity

Expect more activity from the Bank of England as Brexit moves closer to a possible conclusion.

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Since the UK’s 2016 EU referendum, the British economy has been pretty much left to its own devices by our political leaders. The government, its eyes firmly and squarely upon solving the greatest political problem in a generation, seems to have largely forgotten about its everyday business. Promises of hundreds of thousands of new houses, for example, have disappeared into the ether, great talk of unprecedented infrastructure spend likewise. Indeed, it has been left to the oft overlooked department of environment, food and rural affairs to be the government’s chief policymaker in the post-referendum period.

The Bank of England (BoE), though, seems to have finally emerged from its own particular Brexit-induced lethargy.

At its August policy meeting, its monetary policy committee unanimously voted to raise interest rates to 0.75%. The rate rise itself wasn’t surprising but its unanimous nature certainly was.

The UK economy has picked up nicely after its first quarter lull and, with the US set to raise rates at a steady pace over the short to medium term, the BoE is tiptoeing upwards in the background. But the consensus is that the closer we get to 31 March next year, the less likely we are to see further monetary tightening, given the lack of clarity that surrounds the UK’s near-term future. We disagree.

Yes, there is a high level of uncertainty that would come with a ‘no deal’ scenario – one that we maintain is still unlikely – but in its own words, the Monetary Policy Committee (MPC) recognises that there is little slack in the economy. It is absolutely right that rates should nudge upwards in this environment.

Indeed, normalisation of policy should be pursued in the coming months, as now is very much a time at which the BoE should be hoarding policy ammunition.

Having been caught on the hop back in June 2016, sterling has priced in almost all potential bad news this time around. In fact, we probably need to be more aware of a sterling rally in the event of a softer than-expected/less-bad outcome, and the subsequent impact on the (currently unloved) domestically focused areas of the UK market and their more internationally exposed peers. ‘Once bitten, twice shy’ certainly springs to mind; the minute-by-minute focus on both sterling and the UK’s negotiations with the EU suggests a negative shock will be avoided.

Which brings us back to the BoE’s role in the coming months: Governor Mark Carney may well be ready to sail off into the Canadian sunset but his approaching departure – now pushed back six months from an originally planned June 2019 exit – matters not a jot when it comes to the MPC’s immediate policy decisions.

The market is currently giving a 20% chance of a rate hike before the end of next March, and only a 60% chance in the next 12 months1. This seems complacent. With the US Federal Reserve seemingly set on the path of a hike a quarter, we expect the BoE to go again.

1Source: Bloomberg as at 3 September 2018.

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