Brexit Makes Carney's Task Tougher as Draghi Turns Corner

  • ECB now has improving economy and easing of political risk
  • BOE to give economic update on U.K. colored by Brexit concerns

Mario Draghi and Mark Carney are experiencing a role reversal.

Previously plagued by Greece’s fiscal crisis and the rise of euro-skeptic populism, the European Central Bank president now oversees an accelerating economy in which the political risks are subsiding.

In contrast, the once-upbeat Bank of England Governor Carney sees signs that the British economy is being weakened by the decision of voters to leave the European Union.

The change in fortunes is reflected in the outlooks for monetary policy on each side of the English Channel, with Carney set to leave interest rates lower than they might have been without Brexit, and Draghi nearing the moment he can start tightening.

“They almost swapped places -- Carney may be in the same situation Draghi was two years ago, with an economy under threat from political uncertainty,” said Marchel Alexandrovich, an economist with Jefferies in London. “It’s as if Draghi could tell Carney: ‘Politics gave me a tough time and now the focus is back to you’.”

An irony is that some Britons who campaigned for Brexit argued it was necessary to break away from a failing economy. Now the International Monetary Fund is predicting the euro area will outpace the U.K. next year for the first time since 2010, albeit only just. New economic forecasts due from the European Commission on Thursday may also highlight the shift in mood.

On some metrics, the U.K. is still at least as strong as the 19-nation currency bloc. The economy has fared better than expected since the June referendum and the unemployment rate of 4.7 percent is half the eurozone’s 9.5 percent.

Going Dutch

Yet euro-area economic growth last quarter was faster than in Britain for only the second time in the past two years. Addressing the Dutch parliament Wednesday in The Hague, Draghi said that the recovery “has evolved from being fragile and uneven into a firming, broad-based upswing,” though “it is too early to declare success.”

On the political front, France’s rejection of anti-euro Marine Le Pen in favor of centrist Emmanuel Macron for president removed some of the uncertainty that sent spreads between German and French bonds to the widest since 2012. Brexit, Greek aid talks and the possibility of early Italian elections remain potential instability risks, but none seems on the verge of becoming acute.

After years of fighting the threat of deflation, Draghi’s job now is to make sure he doesn’t tighten policy prematurely.

“The ECB is in the very, very early stages of beginning to withdraw stimulus,” said Cathal Kennedy, European economist at RBC Capital Markets in London.

With the weaker pound pushing U.K. inflation above the BOE’s 2 percent target, Carney is also under some pressure to tighten. Kristin Forbes dissented from the majority decision at the last Monetary Policy Committee meeting by calling for a rate hike, and may do so again this week.

Sweet and Sour

Yet Deputy Governor Ben Broadbent has said the current “sweet spot” -- with the nation still in the single market and exporters boosted by sterling’s weakness -- may not last. Rising consumer prices are squeezing households and the economy grew just 0.3 percent last quarter, the weakest in a year. That’s half the pace the BOE predicted.

Conveying that message will be challenging for the MPC -- which is expected to keep the key rate at 0.25 percent -- and for Carney when he presents fresh forecasts in the BOE’s Inflation Report. Not only has the central bank been lambasted by critics for comments on Brexit, but policy makers are in a quiet period before parliamentary elections on June 8 and will be wary of straying from the official script on the central bank’s outlook.

“He’ll have to watch his language, particularly on Brexit,” said Kennedy. “The trade-off they’ve been facing over the last little while is getting trickier.”

After the election, as the March 2019 deadline for exiting the EU nears, political uncertainty might undermine the British economy and complicate the BOE’s communications. Prime Minister Theresa May, who polls suggest will widen her majority in the election, has shown a willingness to accept a so-called hard Brexit -- no single-market access -- if the negotiations sour.

The BOE is unlikely to change its benchmark interest rate before Brexit negotiations are concluded, according to the National Institute of Economic and Social Research.

“For Carney, it’s very clear that the Brexit camp has won the debate domestically, so he has to be seen as a supporter of government policy,” said Azad Zangana, an economist at Schroders Plc. “Draghi has got a clearer path, at least for the next few months.”

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