MNI: BOE State of Play: Gradual Hikes But Brexit The Wildcard

--Hikes are coming, bar a Brexit shock

By David Robinson

     LONDON (MNI) - Bank of England Monetary Policy Committee members have

delivered a common message in remarks this week: gradual rate hikes are very

likely unless Brexit derails things.

     Even if wage growth once again fails to pick up in line with the Bank's

expectations, subdued productivity growth and limited spare economic capacity

means "unit labour costs and inflationary pressure would still pick up as in our

August forecast," according to Deputy Governor David Ramsden, in a speech at the

Society of Professional Economists.

     The latest data was "broadly on track", with wage pressures building,

justifying further tightening, he said.

     But how fast that tightening will come is a moot point. Gertjan Vlieghe,

unlike some of his colleagues on the MPC, is happy to provide an estimate of its

likely pace, but even he gives a range, of one or two hikes per year.

     Money markets are sceptical. OIS curves point to only a little more than a

couple of 25 basis point hikes over three years. The BOE's own sterling

overnight data shows Bank Rate rising from its current 0.75% to 1.35% over three

years.

     --BREXIT THE GAME CHANGER

     With the UK struggling to return to anything like pre-global financial

crisis growth rates, the MPC has lowered its estimate of equilibrium growth to

just 1.5% a year, so even the modest quarterly expansion of around 0.4%

typically seen recently is not widening the output gap.

     BOE Chief Economist Andrew Haldane, in conversation at the Institute for

Government, said growth around trend.

     But, while the central guidance is for gradual and limited monetary

tightening, in the event of a disorderly exit from the EU, changes may not be

gradual and may not involve tightening, Vlieghe said Sept. 25.

     While financial market participants use derivatives to guard again Brexit

shocks, MPC members are continuing to employ a central forecast for a much more

stable picture of trend growth, inflation around target and gentle tightening.

This is based on a simple, un-weighted average of possible smooth Brexit

outcomes - with a transition deal agreed and a steady path to this outcome.

     That creates a disconnect between the Bank's Brexit assumptions and those

of investors, Ramsden said.

     "It is very important to recognize that there are wide range of outcomes on

Brexit priced into markets at present," Ramsden said in a question and answer

session.

     Market participants have taken out options on both a disorderly Brexit and

a very benign Brexit outcome, he said, insuring against tail risks and driving

up implied foreign exchange volatilities,

     He stressed that in the event of a disorderly Brexit there would be

"two-sided risks," and that the MPC could choose to raise or lower Bank Rate

depending on what the relative hits to the supply and demand sides are.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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