Bank of England Leaves Policy Settings Unchanged and Warn Sternly about Dangers of Leaving EU

May 12, 2016

Members of the Monetary Policy Committee were unanimous in retaining a 0.5% Bank Rate and GBP 375 billion limit on the asset purchase program.  Inflation of 0.5% is only a fourth of the 2.0% medium-term target, and the growth slowdown last quarter is projected to extend further in the current one.  Downside external risks will not be fully neutralized.  In fact, officials maintain that a rise in the policy interest rate by the end of the 2-year policy horizon period is more likely to happen than not, but they again reiterated that the normalization of interest rates will be shallower than what has characterized earlier rate tightening cycles.  2.0% inflation is expected to be restored by mid-2018, since the negative output gap should disappear by early 2017.

Today’s policy statement minces no words in describing the many downside risks that officials anticipate if the June 23rd referendum on EU membership results in a decision for the U.K. to exit from the European Union.  Personal consumption and investment are likely to be throttled back.  Unemployment will rise as demand for labor shrinks.  Britain’s supply-side rate of potential non-inflationary growth is likely to slow, too, and the pound is likely to depreciate further, perhaps sharply so.  All in all, growth will be lower, inflation higher, and policymakers will be pressed to trade higher-than-desired inflation against higher-than-desired joblessness.  This choice between two negatives will hinge importantly upon how expected inflation is affected, and ultimately central bank officials seem unwilling to compromise their definition of price stability, which is a medium-term 2.0% rise in prices. 

Bank of England officials are being clearly political, but there is no alternative to entering the should-we-stay-or-go debate under the circumstances.  It is the committee’s collective responsibility to spell out how they expect monetary policy to be impacted by a no decision, so voters have the facts as experts see such when the decision is made.  The policy announcement does not quantify how the various economic variables are projected to trend if there is a vote to leave the EU, and that’s a fair criticism to be made at this point.  However, the executive summary was accompanied by the newly published quarterly Inflation Report.  One sees that some of the referendum’s dampening effect will be irreversible even if voters choose to stay.  The baseline projections, which assume such, have been revised slightly lower for 2016, 2017 and 2018 compared to forecasts released in February.

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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