United Kingdom: BoE keeps the Bank Rate on hold in May; warns about economic impact of Brexit
May 12, 2016
At its 12 May meeting, the Monetary Policy Committee (MPC) of the Bank of England (BoE) kept the Bank Rate on hold at 0.50% and left the stock of asset purchasing at GBP 375 billion. Both decisions met market expectations. Just as in the previous month’s meeting, the Committee voted unanimously on the proposals for keeping both the Bank Rate and the stock of asset purchasing unchanged.
The BoE commented that the British economy had decelerated in the first quarter of this year and that it will likely record another slowdown in the second quarter. The MPC acknowledged that concerns are mounting over the uncertainty associated to the Brexit vote. The Committee expects economic activity to gain momentum later this year, even though growth will likely be below its historical average. At its latest Inflation Report, released in May, the Bank revised down its GDP forecast and now expects the economy to expand 1.9% this year (previously estimated: +2.2%) before accelerating and expanding 2.2% in 2017 (previously estimate: +2.3%). The May projections are conditional upon the assumption that the UK will remain in the European Union following the Brexit vote.
The Bank recognized that the most significant risk to the MPC’s forecasts concern the EU referendum and added that a vote to leave the Union would alter the outlook for growth and inflation significantly, which could in turn change the path of the Bank Rate. With a scenario in which the UK decides to leave the EU, the Committee explained that, “households could defer consumption and firms delay investment, lowering labour demand and causing unemployment to rise. At the same time, supply growth is likely to be lower over the forecast period, reflecting slower capital accumulation and the need to reallocate resources. Sterling is also likely to depreciate further, perhaps sharply. […] The implications for the direction of monetary policy will depend on the relative magnitudes of the demand, supply and exchange rate effects.”
Regarding price developments, the MPC commented that inflation remains well below the Bank’s 2.0% target. It also explained that this is due to large drags from energy and food prices, which are expected to fade over the next year. The Committee added that inflation will likely return to the target by mid-2018 mainly supported by an increase in domestic cost pressures and a decrease in spare capacity. This month, the Bank released a revised inflation forecast for the period ending in Q2 2019 in which it projects inflation to average 0.6% in 2016 (previously estimated: 0.6%) before hitting 1.5% in 2017 (previously estimated: 1.6%). The MPC judges that, “it is more likely than not that Bank Rate will need to be higher by the end of the forecast period than at present to ensure inflation returns to the target in a sustainable manner. All members agree that, given the likely persistence of the headwinds weighing on the economy, when Bank Rate does begin to rise, it is expected to do so more gradually and to a lower level than in recent cycles.”
Author: Dirina Mançellari, Senior Economist