Posen Says Pound Decline May Mark Shift Too Big for the BOEby and
Sterling has dropped 17% since U.K.’s June 23 vote to leave EU
Rise in inflation expectations lowers odds of BOE rate cut
Former Bank of England policy maker Adam Posen said the pound’s weakness may be part of a fundamental shift in the state of the U.K. economy that monetary policy alone can’t tackle.
Posen, who is president of the Peterson Institute for International Economics in Washington, said the BOE’s response to sterling’s slide “goes to the question of how much faith they have this is a one-off shock or not.” The pound has weakened around 17 percent since the U.K.’s vote to leave the European Union in June, and plunged 6.1 percent in the space of two minutes in Asian trading on Friday.
“It’s bigger than what the BOE can do,” he said in a Bloomberg Television interview with Tom Keene and Francine Lacqua on Friday. “It’s a fundamental change to British competitiveness and so I think there’s going to be inflation. It’s not just a question of the BOE’s credibility.”
Posen’s comments suggest it will be up to Prime Minister Theresa May’s government to provide long-term support to the economy as the U.K. wends its way through potentially tortuous exit negotiations with the EU. While BOE Governor Mark Carney was quick to step in with monetary stimulus after the Brexit vote, he’s also been keen to stress the limits of what he can do, saying in August that the “future potential of this economy and its implications for jobs, real wages and wealth are not the gifts of monetary policymakers.”
The pound’s latest decline has implications for the chances of more support from the BOE. Inflation expectations jumped on Friday, with the 10-year break-even rate surging 11 basis points to the highest since 2014. BOE Deputy Governor Ben Broadbent said earlier this week that sterling’s decline since the June referendum had been “relatively orderly” and the policy response would depend on how it affected the economic outlook. The central bank is looking into the causes of the overnight flash crash.
With surveys indicating the economy has performed better than anticipated in recent months, the currency’s precipitous fall is reducing the chances of another interest-rate cut after the August easing. The probability of a rate cut by year-end dropped to 11 percent on Friday, just half of what it was at the start of the week.
Part of the reason for the economy’s resilience has been the impetus for future exports from the weaker currency. Posen said the depreciation is “good for the economy in the short term,” but will be “bad for the medium and long-term.”
“The short term export boost is limited,” he said in the Bloomberg interview.
Asked about comments from the prime minister this week that were interpreted by some as an attack on the BOE, Posen said he has no doubt the bank will maintain its independence. However, he added that with inflation accelerating, the comments may raise the odds of the BOE responding with a rate hike “to show that they are independent.”
May, who said Britain will trigger Article 50 to begin its EU withdrawal by the end of March, has also indicated Britain may end up with a so-called hard Brexit -- which would limit its access to the EU’s single market. Chancellor of the Exchequer Philip Hammond consequently dismissed speculation that the government is turning anti-business.
“The events of the past week probably provide a window into the sort of volatile economic environment the U.K. will face over at least the next two and a half years,” said Rob Wood, an economist at Bank of America-Merrill Lynch in London. “That environment is unlikely going to be good for growth.”