MNI INTERVIEW: BOE Using Unrealisable Brexit Forecast: NIESR

--BOE F'casts Based On Unachievable Average Brexit Outcome: NIESR's Young

--NIESR Opts For Most Likely Outturn In Forecasts: Young

By David Robinson

     LONDON (MNI) - The Bank of England will once again base its August

Inflation Report projections on a smooth transition to an average of Brexit

outturns, an outturn it knows cannot materialize, a former BOE advisor told MNI.

     "The difficulty with the Bank's approach is that we can be pretty sure that

the final outcome will be one thing or another and not a mixture of possible

outcomes," said Garry Young, Director of Macroeconomic Modelling and Forecasting

at the National Institute of Economic and Social Research and a BOE veteran.

     The BOE's approach to Brexit introduces an element of unreality into its

projections as the UK will eventually end up in one or another of the various

Brexit options and not in an average of them. Young, who until Sep 2017 worked

on monetary policy and modelling at the BOE, questions the central bank's

approach, suggesting outcomes could give skewed forecasts.

     --BIASED FORECAST

     The Bank assumes that the UK moves in an orderly way through Brexit and

ends up trading with the EU based on the average of outturns ranging from World

Trade Organisation rules to a Norway style arrangement, where it would still be

part of the single market.

     "By weighting on outcomes that may have little chance of happening it is

likely to be producing biased forecasts," Young said.

     The risk is that the Bank's Monetary Policy Committee (MPC) will set policy

differently to what it would have done had it adopted differing methodology.

     Since the BOE published its May Inflation Report the Brexit saga has

evolved, with the government publishing a White Paper setting out its preferred

Brexit outturn. This was for a free trade area for goods but with services trade

subject to the restrictions of an equivalence regime under which both the UK and

EU would have to be satisfied that their regulations achieved the same outcome. 

     NIESR on Tuesday published detailed analysis of the White Paper scenario

and compared it to a soft Brexit scenario. NIESR estimated a loss of around 2.5%

to GDP over 10 years under the White Paper scenario, with inflation markedly

higher, by on average 1.4%, due primarily to sterling depreciation.

     The BOE will offer no comparable analysis when it publishes its projections

Thursday.

     "By taking an agnostic approach it is able to get on with its job of

setting monetary policy without being castigated for conditioning its forecasts

on an assumption that will be anathema to some politicians and also potentially

wrong," Young said.

     The proposals in the White Paper itself are widely expected to end up being

heavily modified in any final deal, with the EU putting pressure on the

government to choose between a softer Brexit than it envisages and no deal.

     --OUTCOME REACTION UNCLEAR 

     Market participants, instead, will be left guessing over how the MPC will

react if a markedly softer Brexit emerges or if the UK crashes out with no deal.

     "Market participants can draw on the Committee's track record of managing

the trade-off that emerged after the referendum .. the policy response would

reflect the balance of the effects of a sharper Brexit on demand, supply and the

exchange rate," Young said.

     Following the June 2016 referendum the MPC opted to extend the period over

which inflation was expected to return to target in order to support jobs and

activity and there is an expectation it would do the same thing in the event of

a hard Brexit. Carney will again doubtless be questioned over Brexit, but he is

unlikely to shed any fresh light on it.

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

--MNI London Bureau; +44 203-586-2226; email: jamie.satchithanantham@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MX$$$$,M$$BE$]