For the bulk of 2018 I have written extensively about how a no deal Brexit scenario benefits the Bank of England in continuing to tighten monetary policy.
As covered in my last blog post (Are Both Sides of the Brexit Divide Being Played for Fools?), BOE governor Mark Carney has indicated that in the event of reverting to World Trade Organisation terms the most likely outcome would be for the bank to raise – not cut – interest rates.
As far back as three months ago, Carney used a press conference following August’s Inflation Report to make it clear to the media and public alike that for rates to be slashed in response to no deal, the ramifications would have to be dis-inflationary. Given that one of these ramifications would be a precipitous fall in the value of sterling, which would accentuate inflation, the suggestion by anyone that dis-inflation would be a problem is highly illogical.
This past Thursday the BOE presented their November Inflation Report, and whilst they left interest rates unchanged at 0.75%, Carney used the opportunity to further signal that a no deal exit from the EU will result in rates rising:
There are scenarios where policy would need to be tightened in the event of a no-deal, no transition so-called disorderly Brexit but I would stress that it is not the view of the committee that that is the most likely scenario.
Rather predictably, mainstream journalists have called Carney’s bluff. One of those is Ed Conway, Economics Editor for Sky News:
It seems frankly implausible that the UK could face a recession and that the Bank would decide to exacerbate the financial pain by lifting borrowing costs. It just doesn’t happen.
Conway goes on to say that prior to the 2016 referendum, the BOE warned that rates may have to rise if the country voted to leave the EU. By his own admission, Conway perceived this as ‘deeply implausible‘, a position he attempts to reinforce by stating that ‘at the first practicable moment after the referendum the bank cut interest rates.’
This is disingenuous at best by Conway. A month prior to the referendum, Carney said this on delivering the May 2016 Inflation Report:
A vote to leave the European Union could have material economic effects on the exchange rate, on demand, and on the economy’s supply potential, effects that could affect the appropriate setting of monetary policy. A further fall in sterling would boost inflation over the policy horizon.
This combination of influences on demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation.
Everything that Carney warned about – call it preemptive programming or otherwise – came to pass. What Conway failed to inform his readers on is how when the BOE cut rates in August 2016, they did so with inflation running at just 0.5% – significantly below the bank’s 2% target for inflation.
In other words, the effects of a leave vote that Carney warned about took time to feed through the financial system. Once inflation passed 2% and worked it’s way notably higher, the tone of the BOE changed from ‘dovish‘ to ‘hawkish‘. During the same period the Federal Reserve and the Bank of Canada were also in the midst of tightening policy (and continue to be to this day).
Seventeen months after the leave vote, the Bank of England raised interest rates. The warning that they might in response to the referendum was founded.
Once again, the incredulity expressed by Conway two years ago is repeating itself. But he is not alone. Larry Elliott of the Guardian considers the warning of rates rising off the back of a ‘disorderly‘ Brexit as an attempt by the bank to ‘focus minds‘ on the government securing a deal with the EU and the implementation of a transition period. Elliott dubs this ‘Project Fear MK II‘, which on this occasion ‘might just work.’
As Conway and Elliott doubted the validity of Carney’s words, Bloomberg ran an article discussing the scepticism amongst economists that the BOE would follow through with their warnings. Samuel Tombs of Pantheon Macroeconomics was quoted as saying that,
It is possible that they could raise rates but I just think that would be contrary to their instincts at that time. Their initial reaction will be to try and cushion the blow.
What Conway, Elliott and Tombs have not factored into their analysis is that the ‘normalisation‘ of monetary policy is a global initiative, the roots of which can be found at the Bank for International Settlements. This is something I discussed in depth last year (‘Normalisation’ of Monetary Policy: The Candour Behind the Curtain). The pace of ‘normalisation‘ may differ between banks (the Fed have raised rates six times over the past eighteen months whilst the Bank of England have moved twice), but the intention is the same. Central banks are retreating from a decade of monetary accommodation at a time when global political ‘populism‘ is on the rise. A fact that I do not consider a coincidence.
Bereft from mainstream coverage also has been that following the ‘Great Financial Crisis’ in 2008, the BOE tolerated above target inflation over a four year period. During this time inflation reached as high as 5%. The policy response? Rates remained at record lows as the bank continued with quantitative easing. To have begun raising rates then would have placed all the emphasis on the BOE’s actions and left them culpable for an ensuing economic downturn. Geopolitically, there was nothing for the bank to fall back on.
The situation now is the polar opposite. Whichever side of the Brexit divide you constrain yourself to, it cannot be denied that only since the advent of Brexit has the policy stance of the BOE shifted. Listen to Mark Carney speeches today and time and again he refers to the BOE’s remit for 2% inflation and how the decisions they take must be in regard to this target. Quite clearly, the bank’s inflation target matters again. The decisions made by the BOE’s Monetary Policy Committee are being implemented in response to Brexit, which in turn provides the bank with the justification to be able to ‘normalise‘.
The sad fact is that mainstream economists are notoriously complacent. Months before the Bank of England raised rates for the first time in a decade last year, the consensus was that the bank would not move on rates until at least 2019. I predicted in the summer of 2017 that the BOE would raise rates before the year was out, mostly because of the prevailing trends that were evidently growing throughout the central banking community.
Crucially, communications from the Bank of England are being supported by actions. This is also the case with the Federal Reserve. In my view, Mark Carney is forewarning markets and the public of what will follow if the UK vacates the EU with no agreement. The incredulity of Ed Conway, Larry Elliott and others serves only to deflect attention away from the reality of what potentially is about to happen.