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Where Next For The Bank Of England?

It’s foreseeable that we may enter into a bit of a funny patch for the Bank of England in the first quarter of 2020. Through the trials and tribulations of the previous government’s attempts to pass a Brexit bill through parliament armed with an ever-shrinking majority as well as a fairly united front of opposition from European big hitters, the central bank was cautious about being seen to enter into the political fray. Mark Carney may have stuck his head above the parapet with his views on Brexit early on, but for the most part the BoE has been consistent in voicing a “wait and see” stance on negotiations. With a 31 January Brexit looking pretty certain, that waiting and seeing is approaching the end of its shelf life but it also coincides with the end of Mark Carney’s term as Governor of the Bank of England.

Flexing political muscles

Sterling rallied on last week’s resounding Conservative victory (or rather on the resounding victory of a political party that would be able to break the deadlock and move the United Kingdom beyond its current deadlock.) However in the first half of this week it appears to have shown an interest in market data – something of a rare occasion for a currency that has been so politics and macro events-driven. Weaker PPI and retail numbers this week have helped to shed those post-election gains. Tomorrow’s vote in parliament could change that. Following the Queen’s speech this morning (in which Her Majesty reaffirmed Her Government’s pledge that they will leave the European Union by January 31 2020), the Prime Minister will introduce the Withdrawal Agreement Bill (WAB) later today, with Members of Parliament voting tomorrow. It is expected that contrary to the acrimony and wrangling that accompanied previous failed attempts, this Bill will be a near-formality with all 365 Conservative MPs having pledged to back it. After this vote (around 14:30 GMT) should it be successful it will pass to the committee stages. On returning from their Christmas recess on 6 January, MPs will have time to further debate the WAB bill, after which it is expected to pass to the House of Lords where Peers will have up to two weeks to debate the Bill. Following this, MPs will be able to debate any changes made, with the Bill scheduled to receive Royal Assent on 27 January.

All of this process leaves space for hiccups along the way. But it is unlikely. Tomorrow we will see the first real show of how Boris Johnson’s 80-seat majority translates from political stats into parliamentary action. With it, it is highly likely that we will see sterling recoup some of those lost gains.

BoE sees no deal as less likely

Speaking at a press conference after the publication of the Bank of England’s Financial Stability Report earlier this week, outgoing BoE governor Carney said that “The worst-case scenario is effectively a no deal, disorderly Brexit. The probability of that scenario has gone down because of the election result and the intention of the new government,” adding that: “The scenario itself and the risks that we protect the system against has not itself changed, it’s just become less likely.”

So where does this leave the Bank of England’s monetary policy and its effects on longer-term sterling direction? We have been sceptical of chatter about short-termist policies from the central bank to fight softening of economic data. That kind of activist meddling isn’t really the current Governor’s jam, nor is it that of many of the favourites to replace him as Governor. In today’s minutes, the Monetary Policy Committee stated that: “Monetary policy could respond in either direction to changes in the economic outlook in order to ensure a sustainable return of inflation to the 2% target. The Committee will, among other factors, continue to monitor closely the responses of companies and households to Brexit developments as well as the prospects for a recovery in global growth. If global growth fails to stabilise or if Brexit uncertainties remain entrenched, monetary policy may need to reinforce the expected recovery in UK GDP growth and inflation.” However the Committee added that: “Further ahead, provided these risks do not materialise and the economy recovers broadly in line with the MPC’s latest projections, some modest tightening of policy, at a gradual pace and to a limited extent, may be needed to maintain inflation sustainably at the target.”

At Labarde Management, for a long time our base, most-likely scenario for Bank of England policy given long-running trends in data and in economic slack in the UK economy is that post-Brexit we will see a move to this aforementioned tightening policy. As ever, there are risks from global macro conditions that could put the brakes on any hike, but a return to tighter policy, whether modest or not, (and a normalisation of interest rate policy more generally after a sustained period of inertia) would be long-term bullish for sterling – particularly given the very low degree of likelihood that we will see any tightening of rates from the European Central Bank in 2020 and a fairly low chance from the US Federal Reserve.

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