Will “Smooth Brexit” Assumptions Satisfy Lawmakers?
Tuesday’s Inflation Report Hearing promises to be one of the standout events this week, as Bank of England Governor Mark Carney prepares for another feisty encounter with members of the Treasury Select Committee.
The hearing is an opportunity for members of parliament to quiz the BoE on a number of topics including its monetary policy outlook. Needless to say this naturally makes this a potentially high volatility event, especially when you consider some of the key takeaways from the report itself a couple of weeks ago.
The event itself can last a few hours during which the pound, FTSE and UK bonds can be quite volatile. It’s worth noting the correlation between the currency and the index, with FTSE companies generating a large portion of their profits abroad. A weaker currency therefore flatters the numbers when it comes to earnings season as companies report in sterling.
What were the key takeaways from the inflation report?
The part of the report that markets were most drawn to was unsurprisingly the growth and inflation forecasts, both of which were revised lower over the next three years. Traders took this as a sign that the BoE would hold off on raising interest rates for some time, most likely until after the Brexit negotiation has been completed.
Inflation Forecasts
2017 – 2.64% (2.72% in Feb)
2018 – 2.2% (2.56%)
2019 – 2.26% (2.36%)
Growth Forecasts
2017 – 1.9% (2% in Feb)
2018 – 1.7% (1.6%)
2019 – 1.8% (1.7%)
What traders appear to have overlooked though was the acknowledgement that some MP members would need relatively little upside news on growth or inflation to consider voting for tighter policy. With inflation last week spiking – albeit largely due to the timing of Easter – unemployment falling to more than 40 year lows and retail sales rebounded much more strongly than expected, perhaps more should have been made of this warning.
What can we expect from the hearing?
Given how much the Monetary Policy Committee has struggled with its forecasts – particularly since the EU referendum – I would be very surprised if Carney and his colleagues weren’t grilled on the latest batch. The fact that the BoE has based its forecasts on the assumption that the UK will experience a smooth Brexit will also likely be challenged, particularly given the warnings ahead of the referendum. Carney’s warnings about the economic impact of voting to leave left him rather unpopular with eurosceptic MPs and these hearings are a great opportunity to highlight just how wrong the bank has so far proven to have been.
That said, with inflation still creeping higher and data last week showing that inflation was now outpacing wage growth – so wages are now falling in real terms – the inaccuracy of the MPC forecasts may yet prove to have been more so in the timing of the slowdown than the slowdown itself. Something I’m sure Carney will be eager to highlight having faced plenty of criticism.
Given the BoEs failings in the past in respect to its forecast, this may bring the committee to question the point raised earlier that markets appear to have overlooked. Should Carney indicate that a majority would require little more upside in growth or inflation to consider voting for tighter policy, traders may sit up and take notice.