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The Bank of England is on the verge of becoming the largest of the major central banks, with British decision-makers favoring the wait-and-see approach as their US and European counterparts prepare further stimulus packages.
The US Federal Reserve is poised to cut interest rates this week, and the European Central Bank has paved the way for rate cuts and stimulating badet purchases amid persistently low inflation. But the British Monetary Policy Committee (MPC) is in an abnormal position.
Andy Haldane, chief economist of the BoE, drew attention last week to the "unusual position of Britain in the middle of the Atlantic", with real interest rates as low as in the euro area even though its labor market is as strong as that of the United States. The UK's monetary policy already seemed "relatively accommodative" and there was no reason to believe that the BoE would act at the same level as its global counterparts, he said, adding that it would be prudent to do not reduce interest rates "unless there is a marked economic downturn".
A disruptive and unceremonious Brexit at the end of October – which now seems more likely after the appointment of the new British Prime Minister Boris Johnson – would cause such a shock on the economy.
Johnson took office last week promising to take the UK out of the EU before October 31, the date of his planned departure – with or without an agreement.
That's why the MPC is certain to leave its policy unchanged when it presents new economic forecasts on Thursday, even though it has been signaling for months that a "gradual and limited" rise in interest rates will necessary to curb inflation. exceeding its target of 2%.
"A new Prime Minister, a likely change in tax policy and lingering uncertainty about Brexit are pushing the MPC to continue its wait-and-see approach," said Martin Beck, chief economist at Oxford Economics UK.
But the big challenge the MPC will be facing this week is to explain its decision.
Brexit has considerably magnified the existing tensions in the MPC's communication, as its forecasts badume a smooth exit from the EU, but they are based on market expectations of interest rates reflecting the growing risks of issue without a transaction.
"The bank's current forecast does not give a complete picture," said Paul Dales, of Capital Economics consulting firm, who described this week's meeting as "one of the bank's biggest challenges in the world." communication matter ".
Philip Shaw, an economist at Investec, said the conflict between the BoE's benevolent Brexit badumptions and the market view that a hard Brexit could lead to a rate cut meant that "in this case the BoE would have little practical relevance. "
In May, the markets were expecting interest rates to rise by a quarter point over two years. It is on this basis that the BoE forecasts indicated inflation at 2.2% after three years.
Since May, the pound has weakened – a move that will push up consumer prices – and the implied path of interest rates has fallen sharply as investors expect a rate cut quarterly by the end of the year. Unless the MBM takes a more pessimistic view of the economic outlook, its new forecasts will show that inflation far exceeds the BoE's goal.
Under normal circumstances, this would be seen as a sign that interest rates should rise. But as stated by Michael Saunders, external member of the MPC, last week, there is now "a tension, a disparity between forecasts and the vote of policy".
A majority in the MPC has long resisted calls for a more transparent approach, publishing forecasts based on members' views of the most likely path of interest rates.
But Brexit forces the BoE to recognize the difficulties inherent in its current approach.
Mark Carney, BoE governor, said in a recent speech that the MPC would explore the best way to illustrate the "sensitivities" around its forecasts at its meeting in the month of August.
A low-key option would be to put more emphasis on the forecasts it is already producing, showing what it thought would happen if inflation rates remained stable. This would indicate a smaller overrun of inflation.
A larger gap from current practice would be to publish separate projections for a non-transaction scenario. This would be a much more important step: Mr Shaw notes that this could "be seen as a commitment to a specific policy response" if no agreement were to materialize.
Until now, the collective opinion of the MPC was that interest rates could evolve back and forth after a chaotic Brexit. Even in the event of a significant demand shock, a disruption in supply, coupled with the likely fall in the pound and the imposition of tariffs, would fuel inflation. and the MPC should decide where the balance is. Some committee members – including Gertjan Vlieghe, the biggest advocate of a change in communication – now share the view of the markets that a rate cut would be the most likely outcome.
The most radical option – that advocated by Mr Vlieghe – would be to publish forecasts based on the point of view of the MPC on the evolution of interest rates. For most of his colleagues, however, this may be a step too far now.
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