As expected, the Bank of England's (BoE) policy decisions kept both the Bank Rate and stock of purchased assets unchanged at 0.50% and GBP375bn, respectively. Both votes were unanimous (9-0). Some of the initial GBP appreciation is likely linked to some speculation about whether one member would vote for an immediate cut. As we argued after the latest BoE meeting in April, the BoE will not do anything ahead of the EU referendum as it says that the '[...] underlying economic momentum [is] harder to interpret at present'.
Today's focus was on references in the minutes, Inflation Report and/or press conference to the UK's upcoming EU in/out referendum. The BoE repeated that the uncertainty related to a Brexit is weighing on the economic activity ahead of the referendum day which explains why it has lowered its expectations of Q2 growth to 0.3% q/q from 0.5% q/q. However, this may even be too optimistic given that UK PMIs across sectors are at three-year lows (see chart). It is also interesting that the BoE says that the impact may persist after vote.
BoE reiterated that a Brexit ' could materially affect the outlook for output and inflation ' . In line with our view, the central bank says that higher uncertainty about UK-EU trading relationships could slow consumption growth, lead to falling investments and hit the labour market through lower employment. It is also likely that GBP will depreciate, 'perhaps sharply'. In the subsequent press conference, Carney even said that the UK probably faces a recession in the short term in case of a Brexit . Carney declined to comment on the long-term economic impact of a Brexit.
The BoE also repeated the message from the April meeting that ' whatever the outcome of the referendum, the MPC would use its tools to achieve its inflation remit '. The latter we interpret as a sign that the BoE is ready to ease monetary policy if necessary . Although there is some speculation that the BoE could increase the Bank Rate as a response to higher inflation through a sharp GBP fall in case of a Brexit, we think the BoE will look through this due to the negative impact on demand. The BoE did the same thing after the crisis when the Bank Rate was kept at 0.50% despite above-target inflation.
If the BoE needs to ease monetary policy, it has several instruments to hand: It could lower the Bank Rate from 0.50% to 0.00% (currently, the BoE has ruled out negative rates), it could resume the QE programme (APF) and it could ease credit through an extension of the 'Funding for Lending Scheme' (FLS). Interestingly enough, Carney hinted that the BoE prefers to lower the Bank Rate before using other tools .
Overall, the market reaction was limited , although we saw a slightly stronger GBP. Markets price in a 36% probability of a BoE cut before year-end 2016.
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