Carney Faces Scotland Redux Amid U.K. Election Deadlock

For Mark Carney, policy decisions may be starting to feel like a hangover from the Scottish referendum.

The Bank of England governor and the Monetary Policy Committee left their key interest rate at a record-low 0.5 percent Thursday after processing their last round of economic forecasts before the general election. With the May 7 ballot too close to call, economists say officials are taking a wait-and-see approach.

It’s a similar situation to last year’s Scottish independence vote, when close polling just before the plebiscite supported the case for doing nothing. This time around, below-target inflation and the risk of a Greek exit from the euro area give Carney more room to maintain borrowing costs at a record low as policy makers await annual pay negotiations seen as a barometer of price pressures in the economy. Investors are betting the benchmark rate will stay at 0.5 percent this year.

“The election is a reason for them to sit tight and keep policy comment quiet,” said Victoria Clarke, an economist at Investec Securities in London. “Given the softness of inflation, they’ll also want to have a bit more evidence than otherwise that wages are on an upward trend.”

All 47 economists in a Bloomberg survey predicted the BOE would keep policy on hold today. The median forecast in a separate poll is for no change until the fourth quarter.

Political Instability

Opinion polls suggest neither Prime Minister David Cameron’s Conservative Party nor the Labour opposition will gain enough votes in the election to govern alone, raising the specter of years of political instability.

The rise of the U.K. Independence Party creates a particular complication. UKIP is campaigning to leave the European Union, which buys half of all British exports. In response, Cameron has promised a referendum on EU membership if he’s re-elected.

That could throw a wrench into business sentiment, echoing the damage created last year by the prospect of a Scottish separation from the U.K. In the end, a larger-than-forecast 55 percent of voters in Scotland chose to keep the union with England and Wales.

“They’ll be looking at the evidence from the Scottish referendum, which was an example of major political uncertainty,” said Stuart Green, an economist at Banco Santander SA in London. “Now, the upcoming general election and the wage round are the two big uncertainties for the U.K. Policy decisions are on hold at the moment.”

Market Concern

Currency markets are already displaying concern, with implied price volatility in the pound against the dollar for the next six months now at its highest level since June 2012.

“There are signs of business confidence being hurt a bit by deep uncertainty on the formation of a new government,” said Brian Hilliard, an economist at Societe Generale SA in London. “The convention is that central banks don’t move around an election.”

The drop in oil prices since mid-2014 has pushed U.K. inflation down to 0.5 percent, compared with the BOE’s 2 percent target, and the rate may slip below zero in the coming months. Sonia forward contracts are pricing in just 19 basis points of tightening by March 2016. The 10-year gilt yield fell to a record low of 1.33 percent on Jan. 30.

The weaker price outlook also prompted MPC officials Martin Weale and Ian McCafferty to drop their call for an interest-rate increase last month.

Pay Pressures

A push for tighter policy may return if data on pay show inflation pressures building. About 40 percent of U.K. wage deals are settled in April. Policy makers won’t have the figures until after the election, giving them more reason to sit tight.

Britain is also facing headwinds from the euro area, where the European Central Bank has pledged to pump 1.1 trillion euros ($1.3 trillion) into the economy to revive growth and inflation. Further clouding the outlook are talks between Greece’s newly elected anti-austerity government and the country’s creditors over its debt and the terms of its bailout.

The European Commission lowered its 2015 growth forecast for the U.K. on Thursday to 2.6 percent from 2.7 percent.

Surveys this week suggested the economy picked up some momentum in January. The boost to consumer spending from cheaper oil may mean investors misjudge the timing of the first interest-rate increase, raising the possibility that Carney pushes back against market expectations when he presents the BOE’s Inflation Report at a press conference next week. Gilts have returned 3.1 percent this year.

“The BOE probably will want to lean against some of the rally in fixed-income markets,” Kevin Daly, an economist at Goldman Sachs Group Inc., said in a Bloomberg Television interview. Still, “with the euro zone and ECB easing so aggressively, they’ll be wary of sounding too hawkish.”

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