Comment on Bank of England’s decision to keep rates on hold despite Brexit

Léon Cornelissen, Chief Economist, Robeco

Leon Cornelissen

“It’s a surprise because Carney had earlier said that he anticipated looser monetary policy to be needed to cushion the economy over the summer. Still, the MPC has now strongly signaled that a rate cut and more quantitative easing in August is more likely following the publication of its new economic forecasts.”

“Interest rates are already at an historical low, and the Bank has said that it is not comfortable with negative rates, so its room for maneuver is limited. It can now easily refrain from action by saying it needs more economic data. Nevertheless, markets had anticipated a modest pre-emptive strike, but while probably also realizing that such a modest rate cut wouldn’t prevent a UK recession that may well come because of the Brexit decision.”

“In the meantime, the future relationship between the UK and EU remains uncertain, and this will dampen investment. There will be rising import inflation as a consequence of the weak pound, which will lower consumer spending.”

“The new prime minister Theresa May has appointed Brexiteers into important government posts to handle divorce negotiations with the EU, but the strategy is still unclear. The government will have to choose between the free movement of labor and getting full access to the Single Market, and that won’t be easy.”

“The frivolous goodbye of Cameron International and the appointment of Johnson as foreign secretary has provoked sharply negative reactions in Europe. It is important to keep in mind that Johnson’s power will be limited and negotiations will be handled by the new SEE U secretary David Davis. Power has drifted from the Foreign Office to the PM and the new Chancellor of the Exchequer, Philip Hammond. So in a way, Johnson has been neutralized, which will probably be welcomed by many.”

“Theresa May saying that ‘Brexit means Brexit’ is basically meaningless unless Article 50 is invoked. And it’s not likely to be invoked until the end of this year, or early next year, and maybe even later or not at all. The UK is in limbo and producer and consumer confidence will suffer as a consequence. “There is also talk of a general election to get a mandate for the new PM’s administration, but the longer it takes to hold one, the more likely it is that the UK economy will drift into a recession, and that makes holding an election more and more unpalatable.”

“The main Brexit-related fear is that it will embolden euro-skeptic parties all over the EU, but of course the ongoing political and economic chaos in the UK can also have a contrary effect by demonstrating that it’s not worth it.”

“The first test will be the referendum on constitutional reform in Italy: Renzi has announced he will resign if he loses. He’s now running into political difficulties because of the Italian banking crisis which has been exacerbated by the Brexit vote. New European rules in principle would necessitate a bail-in of Italian bank bondholders. However, subordinated debt has been sold to Italian households, so a bail-in is a political impossibility.”

“We feel that a compromise is possible at the European level to prevent such a dilemma and help Renzi, as major European politicians are fully aware that his demise would threaten the integrity of the Eurozone and cause another crisis.”