Oliver Blackbourn, a portfolio manager on the UK-based Multi-Asset team, discusses the Bank of England (BoE)’s decision to keep interest rates on hold despite a deteriorating economic backdrop.
Stuck in the mud, the Bank of England remains frozen in its policy stance ahead of the 31 October Brexit deadline. The slide in GDP growth to 1% year-on-year was not enough to push the Monetary Policy Committee to act. Domestic political uncertainty makes it very difficult for the Bank to respond to a deteriorating economic backdrop without compromising its ability to react if needed after a potential hard Brexit at the end of October or beyond.
Both survey results and production data suggest that various sectors of the economy are shrinking or close to, and inflation continues to slide with the core measure falling to 1.5% this week. Yet wage growth is trending higher, indicating that degrees of domestic economic health remain and future inflationary pressures may be building. All the while the Bank is waiting for resolution of the chaotic political situation so that it can have greater clarity about the expected economic environment and how it should set interest rates. It is important to remember that the Bank uses the official position that a smooth Brexit will occur when giving guidance about the future. The Bank has worked to provide better indications about the range of possible outcomes, but this assumption continues to look naïve, if politically more palatable. The latest addition to the guidance was the suggestion that inflation was likely to fall in the event of a further extension as uncertainty would continue.
Adjusting for the fact that index-linked gilts do not reference the consumer prices index (CPI) rate of inflation, real yields in the UK are at the most extreme negative end among advanced economies, indicating the level of concern about future growth prospects. These low real yields continue to weigh on sterling versus other major currencies, with speculators remaining very bearish on the pound. However, a weaker currency remains a boon for some of the larger, global UK companies, helping to offset the significant discount that has crept into UK shares.