MNI POLICY: Saunders: Markets, BOE Disconnect Due Brexit

By David Robinson

     LONDON (MNI) - Bank of England Monetary Policy Committee member Michael

Saunders said Brexit was to blame for the disconnect between his message that

more tightening was likely to be needed and market rate expectations of no rate

hikes through 2020.

     "The disconnect is more to do with Brexit assumptions" than MPC

communication, Saunders said in evidence to the Treasury Select Committee.

     --Saunders noted that the MPC's fan-charts, its probabilistic growth and

inflation projections, under-estimated the uncertainty of the outlook by

excluding the no-deal and remain options.

     "If either were to become the central case, the economic outlook could

change materially," Saunders said in his written evidence.

     --Saunders said a no deal Brexit would likely deliver a hefty kick to UK

growth and that this would be worse if business did not have sufficient time to

prepare.

     "A no-deal Brexit would probably have a significant adverse effect on the

UK's long-term growth prospects, because of reduced openness to international

trade in both goods and services, and the resultant deterioration in the

attractiveness of the UK as a global business location," he said in his written

evidence.

     --Saunders fleshed out his view of the neutral interest rate, the rate that

is compatible with no output gap and maintaining inflation at target, stating

that it would be slightly above 2% in the years to come.

     This would imply that Saunders thinks Bank Rate may have to rise by more

than 125 basis points in the coming years to reach the neutral rate.

     --Saunders reaffirmed his belief that household income growth and

consumption could come in stronger than in the central MPC forecast in May

Inflation Report and, with the output gap closed, this would justify further

tightening.

     "My view at present is that, conditioned on a smooth Brexit, interest rates

are likely to rise somewhat more than the very flat path currently implied by

financial markets over the next 2-3 years. That is a conditional forecast and

not a promise," he said.

     --Saunders said that if there was a no-deal Brexit, policy "could go either

way." with activity hit but with capital investment impacted and inflation

driven up.

     "Lower growth in the capital stock would probably hit productivity and

potential growth. For the same reasons, sterling would probably depreciate

hence, in the short run, pushing up costs of imported goods and services and

causing CPI inflation to rise," he said.

     --Saunders said in a speech Monday that Bank Rate was likely to move

earlier than markets were pricing to around its neutral rate. Markets are not

only expecting flat rates to persist but are putting an around 40% probability

on a rate cut, he said.

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

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