Following commentary from the Bank of England and governor Mark Carney last week, aspects of the media are now beginning to connect a potential no deal Brexit to a steeper rise in interest rates. Hours after Carney gave a speech at the Central Bank of Ireland on Friday, the Independent ran with the headline, ‘No-deal Brexit may force interest rate rise‘, with the strap line stating that rates ‘may need to rise to curb inflation‘. For months I have consistently been warning about this through regular economic updates and articles on the BOE.
Within the Independent article, journalist Ben Chu tells readers that ‘the governor had previously seemed to suggest that a no-deal Brexit could result in a rate cut‘. Chu is referring to a speech Carney gave in May this year which the media interpreted as a firm indication that the Bank of England would cut rates in the event of a ‘disorderly‘ Brexit. Here is what Carney actually said:
- To understand the MPC’s potential response, businesses, households and market participants can draw on the committee’s track record of managing the trade-off that emerged after the referendum, since exactly the same framework would apply.
- As then, the policy response would reflect the balance of the effects of a sharper Brexit on demand, supply and the exchange rate.
- Observers know from our track record that, in exceptional circumstances, we are both willing to tolerate some deviation of inflation from target for a limited period of time and that there are limits to that tolerance.
What outlets failed to inform their readers of is that the Bank of England’s actions post referendum – rates cut to 0.25% and a further £60 billion in quantitative easing – were undertaken with inflation running at 0.5%. In other words, the economy was in a dis-inflationary environment, allowing the bank to continue with monetary easing.
As documented in previous posts, the Bank of England has a remit for targeting a 2% rate of inflation. Whilst Carney’s position today is that there are limits to how tolerant the bank can be to overshooting that target, from 2010 to 2013 the bank was in a permanent state of tolerance. During those entire four years, inflation was higher than 2%. At it’s peak it reached over 5% in 2011. Despite this, the bank carried on with quantitative easing and kept interest rates at a record low of 0.5%. 2014 to 2016 saw inflation drop well below 2%, and for a short spell turned negative in 2015.
It was only after the EU referendum that inflation began to rise once again, with the depreciation of sterling being attributed by the BOE as the cause. This gradually provided the bank with the rationale (which they previously did not have) to reverse ten years of monetary easing. Less than eighteen months after the vote, interest rates rose. The bank moved again last month, continuing to cite the need to return inflation sustainably back to 2%.
In the years following the collapse of Lehman Brothers, central banks the world over acted in concert by slashing rates and purchasing government and corporate bonds with fresh money created out of nothing. By doing so they became the custodian of what analysts still naively term the ‘free market‘. A direct correlation developed between central bank intervention and record highs in the stock market. The overall trend was for banks to be accommodative, and rates to remain at record lows.
The trend today is the opposite. The BOE, the Federal Reserve, the European Central Bank, the Bank of Canada – all are now engaging in tightening, albeit at varying speeds.
Running adjacent to their change of policy has been the rise of protectionism and political ‘populism‘ in the West, with the likes of the Bank for International Settlements warning that a leading consequence will be rising inflation and tighter monetary conditions.
Those who remain of the mindset that central banks will accommodate the fallout from a supposed revolt against globalisation need to look again.
In November last year, Mark Carney confirmed that in the event of a ‘bad‘ Brexit deal the bank may not be able to cut interest rates.
When they hiked rates a month ago, Carney said that for policy to be accommodative following the UK’s exit from the EU, the effects would have to be dis-inflationary. Since early 2017, inflation has been above the bank’s remit. If the no deal scenarios recently discussed by the bank materialise, the consequences will be higher inflation and by extension higher interest rates.
Earlier this month during a discussion about possibly leaving the EU with no trade deal, Carney told a panel of MP’s on the Treasury Select Committee:
- We have a very clear remit to bring inflation back to that 2% target.
- From a monetary perspective, we would look – subject to our remit – we would look to do what we could to support and ease the adjustment. But there are limits to our ability to so do. This scenario we’re talking about which is no deal / no transition, is quite an extreme scenario. It is very easy to see a case where those tolerances would be breached and policy would have to be tighter, not looser.
The bank’s current stance is beginning to mirror their position back in 2016. A month before the referendum, Carney spoke of the possibility that economic growth could contract should the UK vote to leave the EU. At the same time, the IMF warned of a financial downturn if the UK left the union.
Straight off the back of the BOE’s most recent communications, the IMF have now rallied behind the strengthening no deal narrative and warned of ‘dire consequences‘ for the UK economy if Britain drops out with no agreement.
Rather than dismissing this as bluster and ‘project fear‘, it is my belief that central banks are in fact telegraphing what is about to happen.
Brexit is perceived as being a detriment to the Bank of England. The evidence says otherwise. The ‘disorderly‘ Brexit they speak of gives them every opportunity to continue raising rates and avoid direct scrutiny and criticism for their actions.
- Expressing the IMF’s growing concern at the possibility of an acrimonious divorce next March, Lagarde said: “If that happened there would be dire consequences. It would inevitably have consequences in terms of reduced growth, an increase in the [budget] deficit and a depreciation of the currency.
- “In relatively short order it would mean a reduction in the size of the economy.”
- The Bank of England’s governor has warned the cabinet that a chaotic no-deal Brexit could crash house prices and send another financial shock through the economy.
- His worst-case scenario was that house prices could fall as much as 35% over three years, a source told the BBC.
- There were also widespread reports that the governor told the Downing Street meeting that mortgage rates could spiral, the pound and inflation could fall, and countless homeowners could be left in negative equity.
- The minutes from the meeting stated there was greater uncertainty in financial markets over the potential outcome of Brexit.
- The MPC also pointed to increased downside risks from US President Donald Trump’s trade battles.
- “Since the committee’s previous meeting, there have been indications, most prominently in financial markets, of greater uncertainty about future developments in the withdrawal process.”
- Failure to agree a deal with Brussels – which has become increasingly likely as Theresa May faces the threat of rebellion from eurosceptic Conservative MPs – would lead to a sharp fall in the value of the pound, triggering higher inflation and a squeeze on real wages lasting for as long as three years, it warned.
- Outlining widespread potential damage for the economy, similar to warnings made ahead of the Brexit vote, the ratings agency said the squeeze on household finances from a spike in inflation would have the knock-on effect of lowering consumer spending. This would depress economic growth, potentially tipping the country into recession.
- “The cooperation that was seen in 2008 would not be possible in a post-2018 crisis both in terms of central banks and governments working together. We would have a blame-sharing exercise rather than solving the problem.
- “Trump’s protectionism is the biggest barrier to building international cooperation,” he said.
- “Countries have retreated into nationalist silos and that has brought us protectionism and populism. Problems that are global as well as national and local are not being addressed. Countries are at war with each other on trade, climate change and nuclear proliferation.”
- The lira has risen against the dollar after Turkey’s central bank hiked interest rates to 24% on Thursday – the biggest increase in President Tayyip Erdogan’s 15-year rule.
- The hefty 6.25 percentage point rise is the bank’s latest attempt to stem the currency’s collapse.
- The lira is down 38% against the dollar this year despite Thursday’s slim gain.
- The move came despite Mr Erdogan repeating his opposition to high interest rates earlier in the day.
- The UK high street has posted its worst August performance for three years, in further evidence of the pressure on traditional retailers.
- Underlying sales at physical stores slid 2.7% last month, compared with August 2017, with homewares and fashion taking the biggest hit, according to the latest data from the advisory firm BDO, which monitors mid-sized, non-food chains.
- The Manufacturing Purchasing Managers’ Index (PMI), a survey of businesses produced by IHS Markit and the Chartered Institute of Procurement and Supply (Cips), fell to 52.8 in August from 54.0 in July, the lowest figure in more than two years.