Compared to last month, the BoE Point out that the near-term picture for economic activity has weakened. Uncertainty over the outcome of the referendum is having a negative effect on growth. A slowdown was already recorded in opening quarter of the year, from 0.6% to 0.4% q/q, and will continue into 2Q according to the BoE.

Investments may (temporarily) be held back somewhat even after the referendum, and even if “remain” votes prevail, as the relaunching of the projects put on hold would not be immediate.

Beyond the near term, however, if “remain” votes prevail, the BoE expects growth (albeit slightly slower than envisaged in the February IR) to strengthen, supported by robust private demand. If growth evolves as expected (Fig. 1), slack in the UK economy should already be reabsorbed in the course of this year, making it necessary to hike rates. The BoE has repeatedly asserted that f the United Kingdom stays in the EU, the next move will (most probably) be an interest rate hike. The expected timing of the initial hike is still between 4Q this year and 1Q 2017, although the BoE intends to review its assessment of the scenario following the referendum, as data in the present phase must be interpreted with more caution than usual, given the strong interference of the referendum factor.


The BoE would have all the better reason to reassess the scenario in the event of “leave” votes prevailing, and in this case the decision-making process would be complicated. Its mandate is the achievement of the inflation goal, therefore the Bank of England draws up its analysis considering the effects of a potential Brexit on the pound, on demand and on supply, ultimately assessing the net final impact of these effects on inflation.

● STERLING – For what concerns the pound, the BoE, based on recent experience, expects sterling to depreciate further, maybe even violently. This is because the likely deterioration of terms of trade, productivity, and risk premiums, would have a negative effect on the exchange rate. Taken alone, a further depreciation would have the effect of pushing up inflation;

● DEMAND – Aggregate demand should also decrease, as a result of the more restrictive financial conditions, low asset prices, and high uncertainty over the new state of trade relations (by exiting the EU, the United Kingdom would have to renegotiate its trade relations with other countries). Households would postpone spending decisions and businesses would put investment plans on hold, causing a reduction in demand for labour and an increase in the unemployment rate. Global financial conditions could also become more restrictive, dampening Global demand and therefore British exports. Weaker aggregate demand would have an opposite effect compared to the depreciation of the pound mentioned above, pushing down inflation;

● SUPPLY– However, the effect on aggregate supply would also be negative, as the change in trade arrangements and investment models would slow capital accumulation, and create the need to reallocate resources in the economy. The negative effect on supply would result in higher inflation.

The overall combination of effects on demand, supply, and the exchange rate, could have the net effect of leading to “a materially lower path for growth and a notably higher path for inflation” than forecast in the Inflation Report (Figures 1 and 2).

In this case, the BoE would be faced with a trade-off between stabilising inflation or stabilising growth and employment. The monetary policy implications, therefore, would not be automatic: the policy direction will be decided based on the relative size of the effects on demand, supply, and the exchange rate.

However, Carney explained that there limits to what monetary policy can do. While it can dampen the impact of shocks and “adjust” demand in relation to supply, in order to achieve the medium term inflation goal, it cannot do so in the near term, as it is not possible to immediately and simultaneously counter all the effects of a shock.

One aspect of the BoE’s analysis which remains rather clear is the exchange rate.

The BoE estimates that approximately half of the depreciation (9%) incurred by the pound – in terms of the nominal effective exchange rate – from its November highs, is due to uncertainty over the outcome of the referendum. In line with the behaviour observed in the past few months, in case of “leave” votes prevailing, the BoE expects sterling to depreciate further, even violently.

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