Sterling may depreciate sharply, warns Bank of England

With the Brexit referendum just six weeks away, the Bank of England has voted unanimously to maintain its bank rate at 0.5%.

It said this is in order to meet its 2% inflation target in a way that helps to sustain the UK’s growth and employment.

According to the bank’s Monetary Policy Committee (MPC), the most significant risks to its forecast concern the Brexit referendum. These risks include:

  • Sterling likely to depreciate further, perhaps sharply.
  • A vote to leave the EU could materially alter the outlook for output and inflation, and therefore the appropriate setting of monetary policy.
  • UK households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise.
  • Supply growth is likely to be lower, reflecting slower capital accumulation and the need to reallocate resources.

“This combination of influences on demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation,” the MPC said.

It added that there are increasing signs that uncertainty associated with the EU referendum has begun to weigh on the UK’s economic activity.

“This is making the relationship between macroeconomic and financial indicators and underlying economic momentum harder to interpret at present.”

In the MPC’s latest projections, activity growth recovers later in the year, but to rates that are a little below their historical average.

The Bank’s May projection is conditioned on the bank rate “implied by market rates” and on continued UK membership of the European Union, including an assumption for the exchange rate consistent with a successful ‘Remain’ vote.

UK’s Inflation Target Shortfall

According to the MPC, the UK’s 12-month consumer price index inflation increased to 0.5% in March but remains well below the 2% inflation target.

“This shortfall is due predominantly to unusually large drags from energy and food prices, which are expected to fade over the next year,” said a statement from the MPC.

Core inflation also remains subdued, largely as a result of weak global price pressures, the past appreciation of sterling and restrained domestic cost growth.”

The MPC said all its members agreed that, given the likely persistence of the headwinds weighing on the UK economy, when its bank rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent economic cycles.

“This guidance is an expectation, not a promise,” concluded the Bank.

At the May 11 meeting, the MPC also decided to maintain the stock of purchased assets, which is financed by the issuance of central bank reserves, at £375 billion.

Investec’s Sterling outlook

Based in Dublin since 2000, Investec Ireland is part of an international specialist banking and asset management group

“Our continued concern over deteriorating UK economic sentiment surveys, on approach to the June 23rd referendum, appears to have been well founded,” Investec Ireland said in its May 13 market research update, “Brexit in Focus: reading the tea leaves.”

“A trident of disastrous UK PMI surveys on the 3rd, 4th and 5th of May served to demonstrate how concerned British business is at the prospect of the electorate voting to ‘exit’ the EU.

“The significantly lower manufacturing, services and construction PMI prints helped to drag the single currency up off multi week lows of below £0.78 to trade close to £0.7950 over the three days of releases.

But with little in the way of any seismic poll shifts to give the move some added impetus the Pound seems quite happy to sit back and take a breather.

“The past seven days has seen the EUR/GBP rate mired in a 0.7865/0.7930 range, its tightest weekly range in nearly six months,” said the market research update.