As the Bank of England governor prepares to deliver his first speech of 2017 on Monday, a report that Prime Minister Theresa May is pushing toward a so-called hard Brexit is hitting the pound. Should that persist, it has implications for consumer prices, already rising at the quickest pace since 2014, and exacerbates the tensions facing policy makers who are trying to support economic growth without letting inflation get out of hand.
Sterling slid below $1.20 for the first time in more than three months after the Sunday Times reported that May will signal in a speech on Tuesday her willingness to quit the European Union’s single market for goods and services to regain control of Britain’s borders and laws. It’s the outcome seen by many economists as the least desirable, and the one currency traders have fretted about since the U.K.’s June vote to leave the bloc, Bloomberg reported.
“There’s clearly some ongoing debate within the Conservative Party, never mind the country at large, about what form Brexit should take,” said Thomas Sampson, an assistant professor at London School of Economics. “Whether this announcement that we’re expecting this week will lead the bank to dramatically alter its short-term forecasts over the next 6 months to a year, I’m not sure how they’ll respond.”
Pound Slump
The pound slid as much as 1.6 percent to $1.1986 at the start of trading in Asia, dropping to the weakest since the “flash crash” of Oct. 7. It was at $1.1991 at 6:24 p.m. London time.
Government officials told the Sunday Times that they expect May’s comments to cause a “market correction.” The BOE declined to comment on the contents of Carney’s address.
On the day May speaks, data will probably show inflation accelerated to 1.4 percent in December from 1.2 percent, according to a Bloomberg survey. While that’s below the BOE’s 2 percent target, it’s forecast to breach that level within months as the pound’s 19 percent slide since the referendum feeds through to import prices.
The government might hope to line up a new free-trade partnership with the EU eventually, but leaving the single market and customs union in the meantime risks making trade costlier and more complex for British exporters. It may also force banks to act on their threats to move jobs from London.
The latest decline in sterling means BOE officials may have to make the uncomfortable decision between tolerating an even bigger inflation overshoot or tightening policy -- even if that causes more short-term pain -- to keep price-growth in check. The central bank will publish its latest forecasts for growth and inflation on Feb. 2, when it is also scheduled to announce its next policy decision.
Next Move
The BOE is probably still some way from a rate change. The median forecast of economists is for no change from the current record-low 0.25 percent until at least the second quarter of 2019. When that move comes, there’s a higher chance of a hike, according to a survey conducted last week.
The BOE’s Monetary Policy Committee members have a neutral bias on where rates will go next as they monitor the economic fallout from the decision to quit the EU. While the referendum initially spurred them to cut interest rates and resume asset purchases, and to signal that another rate cut was likely, their stance changed after the economy proved more robust than expected.
Should inflation climb to one or two points above the BOE’s target “they’re not necessarily going to panic," Sampson said. “Obviously at some point it would become a problem."