A day after the U.S. Federal Reserve reduced rates for the first time since the global financial crisis, the BoE said it still expected to raise borrowing costs gradually - though this now hinged on a global pick-up as well as a “smooth” Brexit.
“Profound uncertainties over the future of the global trading system and the form that Brexit will take are weighing on UK economic performance,” BoE Governor Mark Carney said.
BoE forecasts showed a one-in-three chance that the economy would be shrinking in annual terms by the end of the first quarter of 2020, even without a disruptive Brexit.
Sterling sank to a fresh low below $1.21 while benchmark 10-year gilt yields fell to their lowest since the BoE launched its most recent round of asset purchases in August 2016, shortly after the Brexit referendum.
“The UK might need to see a pick-up in the global environment - as well as increased clarity on Brexit - for the market to return to expecting rate rises,” HSBC economist Elizabeth Martins said.
The BoE’s Monetary Policy Committee (MPC) voted 9-0 to keep rates unchanged at 0.75%, as expected in a Reuters poll of economists, and said it would not automatically cut rates even if Britain left the European Union without a deal.
New Prime Minister Boris Johnson says he will take Britain out of the EU on Oct. 31 - regardless of whether he gets a transition deal to keep trade running smoothly - prompting markets to price in higher risks of a disorderly Brexit.
The BoE said business uncertainty about Brexit had become “more entrenched” and Carney said the economy would face an “instantaneous shock” after a no-deal Brexit, with sterling and growth both likely to weaken further.
But the BoE’s ability to cushion the blow would be limited by the risk that lower rates might boost inflation by increasing demand for imports that could no longer be readily obtained.
The BoE’s main forecasts, which assume Britain avoids a Brexit shock, now foresee economic growth of 1.3% for 2019 and 2020, down from 1.5% and 1.6% in its previous forecasts in May.
That would leave Britain roughly in line with the euro zone, which Britain regularly outperformed before its decision to leave the EU.
Before Thursday, some analysts had said the BoE might adjust its long-standing message that it expected to raise rates in a limited and gradual way because of the no-deal Brexit risks.
Carney said a smooth Brexit outcome had become a “less dominant” scenario but the BoE’s guidance remained valuable for steering market expectations for monetary policy.
“Quite frankly, markets know where it’s going and if you strip out their no-deal probability weighting, it’s basically where they expect it too,” he said.
The weaker growth outlook comes despite the expectations in markets of a rate cut that the BoE slots into its forecasts.
After Thursday’s decision, markets continued to price in a near 90% chance that the BoE will cut rates by 25 basis points before Carney steps down on Jan. 31, largely because of the risk of Britain leaving the EU with no transition.
The BoE now expects inflation - currently on target at 2% - to be higher in two and three years’ time, and by more than it predicted in May.
Growth and inflation would both probably be slower in the case of a smooth Brexit than its forecasts suggest, due to a likely snap-back in sterling and in market interest rate expectations, the BoE said.
Therefore, inflation in three years’ time would not necessarily exceed the BoE’s target but the BoE still foresaw the domestic economy overheating, requiring higher rates.