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Carney’s swan song has market split on whether Bank of England will cut rates

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Mark Carney, the outgoing Governor of the Bank of England.

Matt Dunham | WPA Pool | Getty Images

Ahead of the Bank of England’s first monetary policy meeting of the decade on Thursday, markets are split on whether outgoing Governor Mark Carney’s last major decision will bring a rate cut.

With the U.K.’s formal departure from the European Union looming on Friday, the Bank of England (BOE) interest rate decision comes at a pivotal moment for the British economy. The current base rate sits at 0.75%.

Following 131 interest rate cuts from central banks around the world in 2019, the market is split almost 50-50 on whether the nine-member Monetary Policy Committee will vote to follow suit.

Two policymakers, Michael Saunders and Jonathan Haskel, voted to cut rates in both of the last two MPC (Monetary Policy Committee) meetings in November and December, while a further two, Gertjan Vlieghe and Silvana Tenreyro, have indicated following weak GDP (gross domestic product) figures that they could vote to cut unless subsequent economic data showed sufficient improvement.

Rebounding momentum

Since the December 12 general election, in which Prime Minister Boris Johnson’s Conservative government consolidated power, economic data has shown an uptick in confidence and activity.

Vlieghe and Tenreyro are therefore likely to remain on hold for now, according to Berenberg Senior Economist Kallum Pickering.

“However, the sharp — but short-lived — deterioration in survey data after the 2016 EU referendum may cast some doubt in the minds of policy makers over the durability of the post-election bounce,” Pickering said in a note Monday.

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Berenberg economists see a 40% chance that a majority of the MPC votes to cut rates, while estimating that the market currently prices in around a 54% chance of a cut compared to 70% two weeks ago.

Their base case is for a 7-2 or 6-3 split in favor of the BOE holding rates, with the minutes and guidance adopting a dovish tone in light of the recent dip in headline inflation below the central bank’s 2% target and a fading of still-elevated inflation expectations.

“Although the positive news since the election will likely keep the BOE in ‘wait and see’ mode, the BOE could downgrade its near-term headline forecasts slightly after the weaker-than-expected hard data ahead of the election in Q4.” Pickering said.

Inflation, Brexit and an outgoing governor

Despite the January data supporting the notion of a “Boris bounce,” the uncertain terrain of 11 months of trade negotiations between the U.K. and EU could render it easier for the BOE to ease monetary policy preemptively, free from political overtones, according to State Street Global Head of Macro Strategy Michael Metcalfe.

The BOE was one of the few central banks to diverge from the global precautionary easing trend from central banks, even though U.K. growth has faltered materially. With tough tones already being struck by British and European leaders, the prospect of key talks over a free trade agreement going awry might be enough to catalyze this.

This thinking was echoed by Matthew Cady, strategist at U.K. investment manager Brooks Macdonald, who said in a note Tuesday that with domestic political risk out of the way, the BOE may have a freer hand to act, and may have to “take the initiative” to mitigate the uncertainty for U.K. businesses arising from U.K.-EU trade negotiations.

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“With interest rates at just 0.75%, there is a real risk of leaving any rate cut too late. Should the UK economic picture weaken in the coming months, the Bank would potentially have to consider much deeper cuts to its policy rate, requiring room that it arguably doesn’t have,” Cady said.

“This asymmetry in policy risk raises the risk of any wait and see approach by the Bank.”

Metcalfe also pointed to State Street’s PriceStats index indicating that U.K. inflation is temporarily benign and “could soon turn,” which he suggested could encourage the BOE to ease while current inflation is low and falling.

“Following Mario Draghi’s last act as the president of the European Central Bank (ECB), it is tactically easier for an outgoing central bank governor to enact an insurance cut and give the successor a clear path to establish their credibility in a measured fashion,” Metcalfe added.

Awaiting the fiscal faucet

Based on U.K. Chancellor Sajid Javid’s fiscal guidance to lift net investment to 3% of GDP and trend real GDP growth to the pre-financial crisis average of 2.7-2.8%, Berenberg projects a high probability of a major fiscal boost arising from the March 11 Budget.

“On top of the 0.2 percentage point (ppt) boost to growth from the rise in planned spending announced last September, we estimate that the Budget plans could add up to 0.6ppt to headline growth this year. It could thus lift the BOE’s November 2019 projection for 2020 from c1.25 to c1.85% – roughly in line with our own forecast,” he said.

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The BOE would need to wait until parliament passes the legislation, likely in May, before raising its outlook, but for now, the upside risks to growth and inflation from fiscal policy could strengthen the central bank’s impetus to hold.

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