MNI ANALYSIS: BOE: Hard Brexit Risks Sharply Higher Bank Rate

By David Robinson

     LONDON (MNI) - Brexit will be primarily a supply shock to the UK economy

and departing the EU without a deal could force Bank Rate sharply higher, the

Bank of England assumed in its scenario analysis published on Wednesday.

     Its assumptions come with a host of caveats, including that there is no

offsetting fiscal stimulus. Nevertheless, the Bank's analysis hammers home how

it cannot be assumed monetary policy will be eased if the government cannot get

its proposed withdrawal deal through parliament.

     In its worst case disorderly Brexit scenario, with lots of border friction,

no transition and no deal, the BOE showed Bank Rate rising from its current

0.75% to 5.5% and averaging 4.0% over the three subsequent years. This spike in

Bank Rate would respond to soaring inflation, which peaks at 6.5%.

     Bank of England Governor Mark Carney and Deputy Governor Ben Broadbent told

a news conference it was foolish to assume that because the Monetary Policy

Committee cut Bank Rate in response to shocks such as the global financial

crisis and the 2016 Brexit referendum result that it would do so again.

     "The financial crisis ... was principally a demand shock ... what's

different about this is that it is first and foremost a supply shock, which then

has demand implications," Carney said.

     "A sharp supply shock with an exchange rate adjustment ... is likely to be

inflationary and in the end we have a remit - we can balance that remit to a

certain extent but we're not going to ignore it," he said.

     --DISORDERLY BREXIT

     In practice, the MPC would struggle to disaggregate the precise hits to

supply and demand in the event of a disorderly Brexit, which would point to

caution over tightening.

     Broadbent said that if the economy is severely disrupted by Brexit monetary

policy will be a sideshow. The Bank cannot do anything to deal with supply chain

disruption and if the supply side is hit hard the MPC cannot sustain excess

growth.

     "We can't get economic output above that supply capacity for very long,"

Broadbent said.

     Markets have tended to react to adverse Brexit news by forcing sterling

lower and either lowering implied rate expectations or leaving them unchanged.

BOE officials have repeatedly stressed that the policy response could go either

way, dependent on the relative effects on demand, supply and the exchange rate.

     A disorderly Brexit, which could result from parliament failing to support

a deal and not managing to get the EU to extend the March 2019 end date, could

put the most severe upward pressure on Bank Rate.

     Another thing that emerged clearly from the BOE scenarios was that a Brexit

deal which results in a close economic partnership with the EU could actually

see growth coming in stronger than forecast by the MPC in November.

     This is simply because the MPC has been conditioning its assumptions on an

average of Brexit scenarios, so a more benign outcome could see it revising up

both growth and supply estimates.

     Again, the likely impact on policy would be uncertain but in its scenario

analysis the MPC assumed Bank Rate would rise gradually, without spelling out

the precise path.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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