It is clear that with the looming deadline for UK’s withdrawal from the EU, the horizon of policy guidance, which the BoE can offer to the markets, is proportionally reducing. After all, the close economic ties acquired during Britain’s stay in the bloc mean that various scenarios of “coexistence” of independent neighbors will have different economic consequences, especially for Britain. Therefore, after the decision to Brexit in March, the paths of UK’s economy development may imply both the need for easing or policy tightening, which now imposes restrictions on the clarity of communication between the Bank of England and investors. Expectations of political uncertainty also create the “ignoring effect” of incoming economic data, which may even dictate the need to raise interest rates at the upcoming meetings.

The market expects members of the monetary policy committee to unanimously vote to keep the key rate at the current level of 0.75%. That is, a positive surprise for the pound at the time of announcement of policy decision may be the votes of some members to raise the rate. A bearish response of GBPUSD may be intensified if some of the committee members will opt for a rate cut to 0.5%.

There are 50 days left before the Brexit deadline, but British Prime Minister Theresa May has not yet prepared a plan for “divorce” with EU that could satisfy all the warring parties in Parliament. Accordingly, the BoE’s best position, i.e. policy with the lowest costs in terms of volatility and sufficiency of stimulus is probably a wait and see stance. Cutting the rate “in advance”, in case of a positive Brexit outcome, may create the need to roll back too much stimulus. An increase in the interest rate may also require future adjustments if the outcome of “hard Brexit” is realized. The complexity of conducting “stress test” in the form of Brexit for the economy is complicated by the lack of historical experience / similar scenarios, so the head of the Bank of England Mark Carney even suggested that the no-deal with the EU could mean a rate hike (due to accelerating inflation).

With consumer inflation approaching the target of 2%, unemployment at the lowest level for 40 years, BoE has basically achieved perfect inflation-unemployment trade-off, and there is little need to make adjustments to the policy at all.

A more accurate assessment of the need to intervene in interest rates will appear in the quarterly inflation report, which will also be published today. Last year, officials had fears that growth would slow down, and inflation expectations would remain elevated, but as we can see, convergence of inflation to the target level accelerated at the end of last year. Therefore, there is no apparent need to raise or prepare the market for rate hikes.

The UK economy issued a warning in January that the services sector, the main driver of economic growth, has almost stopped growing. The Markit report on manufacturing and construction also indicated a decrease in activity and, as firm managers reported, Brexit became the main source of uncertainty.

At the same time, some of the committee hawks (for example, Andy Haldane, BoE’s chief economist) will probably pay attention to a strong wage increase, which is already well ahead of inflation. Being a precursor of consumer inflation, strong wage growth usually accumulates hidden inflationary potential for consumer prices, which can be realized later. There is a chance that the votes of the committee will be divided and considering market expectations that BoE will be completely concerned about Brexit, this outcome may cause significant strengthening of the pound.

Please note that this material is provided for informational purposes only and should not be considered as investment advice. Trading in the financial markets is very risky.

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