Mark Carney Has a New Set of Brexit Problems to Solve

  • Officials may revise forecasts after 3Q growth beat estimates
  • Inflation almost doubled in Sept., damping rate-cut chances

BOE's Carney: U.K Prosperity Relies on EU Relationship

Mark Carney has a new set of Brexit problems to solve.

Since the Bank of England’s last complete set of forecasts and policy loosening in August, a fuller picture of the economic reaction to the U.K.’s vote to leave the European Union has emerged. While growth has cooled less than expectations, inflation has started to pick up thanks to the depreciation of the pound, down almost 18 percent against the dollar since the June 23 referendum.

While the pressure eased a little on Thursday after the pound rose the most since August -- a U.K. court ruled the government must hold a vote in Parliament before starting the two-year countdown to Brexit -- Governor Carney and his colleagues still have to reassess their assumptions for the pace of the slowdown yet again as they prepare for Prime Minister Theresa May to start formal talks.

Price growth looks set to top the nine-member Monetary Policy Committee’s list of concerns for 2017 as they prepare for their final Inflation Report press conference of the year. That briefing will held at 12:30 p.m. In London, half an hour after the central bank announces its policy decision. 

Not only has sterling slumped since the EU vote, manifesting itself in higher import costs, energy prices are also on the rise. Inflation expectations have risen to their highest in nearly three years, according to the 10-year break-even rate, a gauge of the bond market’s outlook for U.K. price growth over the next decade.

With some banks forecasting that consumer-price growth will surge above 3 percent next year, the governor said last week that there are limits to officials’ willingness to look through an overshoot of inflation above their 2 percent target, a sentiment he could repeat at his press conference.

That’s a marked divergence from language used earlier in October and could indicate no policy change is imminent, despite a line in the BOE’s September statement that most officials “expect to support a further cut in bank rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of this year.”

Traders certainly aren’t expecting that to happen, with the implied probability of a reduction in rates sliding since the MPC’s September meeting.

The risks facing the British economy were highlighted in two reports on Thursday. IHS Markit’s Purchasing Managers Index for services climbed to the highest since January, with pound weakness lifting foreign demand but input prices jumping the most since March 2011. The U.K.’s Office for National Statistics said that while the economy has been largely undisrupted so far, rising raw material costs present downside risks.

Even if currency-driven inflation alone isn’t causing Carney too many headaches, the specter of stagflation could loom if Brexit hits productivity, according to Angus Armstrong, director of macroeconomics at the National Institute of Economic and Social Research.

“If Brexit damages the growth rate, then for a country that’s used to seeing 2 1/4-percent growth this could mean that we get the combination of a lower growth plus inflation being perhaps a little bit over target persisting,” he said. “There is the risk that we have this sort of stagflation.”

Yet with prices rising and consumer credit climbing at the fastest pace in a decade, the BOE still seems unlikely to raise rates in the near future. British shoppers -- the engine of the economic recovery -- helped push retail sales up by the most in more than a year in September.

“We expect the BOE to use the November Inflation Report as an opportunity to take stock on the state of the economy and the effectiveness of its policies, while sending a strong signal that the BOE stands ready to do more if economic conditions were to deteriorate,” said Kallum Pickering, senior U.K. economist at Berenberg. “We will be looking closely at the BOE’s assessment of the forthcoming inflationary headwinds to consumption, the impact of hard-Brexit fears on investment, and, if any, the policy implications of the recent weakening of sterling.”

— With assistance by Jill Ward

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