BOE Grapples With No-Deal Brexit Prospect: Decision Day Guide

(Bloomberg) -- Bank of England Governor Mark Carney will confront the new realities of Brexit and the increasing likelihood of a no-deal departure from the European Union in the central bank's interest-rate decision on Thursday.

A sinking pound and lower bond yields mean that BOE forecasts calling for gradual tightening, based on assumptions of a smooth Brexit, could be all but meaningless. Carney said last month that the BOE is looking at ways to address the unprecedented divergence between market rate-cut pricing and the BOE's projections. The benchmark is expected to stay at 0.75%.

Emphasizing the government's seriousness about leaving the EU on Oct. 31 -- with or without a deal -- it's set aside an additional 2.1 billion pounds ($2.5 billion) to prepare for no deal. Separately, a report Thursday showed British factories in the worst slump in six years.

Here are some of the things the Monetary Policy Committee will be considering.

Currency Pain

The pound has slipped about 4% on a trade-weighted basis since the last round of forecasts in May, increasing the potential for faster inflation in the medium-term. A shaky second-quarter means lower near-term growth predictions, something the BOE might focus on if it wants to sound more dovish.

As the deadlock between Prime Minister Boris Johnson and EU negotiators continues, the pound has the potential to plummet further. Bloomberg economist Dan Hanson estimates that sterling could fall an additional 13% in a no-deal scenario.

Rate Cuts Ahead

A year ago, the BOE raised its key rate to 0.75% and said further gradual tightening would probably be needed if the economy performed as expected. But the situation has changed dramatically, and rates have been on hold since.

• For more insight from Bloomberg Economics, click here

Amid the prolonged uncertainty, the central bank and the markets have looked increasing at odds as traders become more pessimistic about the possibility of a smooth Brexit. But there may be a shift in tone coming. Policy maker Michael Saunders said last month that the official forecasts may have less influence given the Brexit risks hanging over the economy.

Record Employment

The U.K. labor market remains the most buoyant part of the economy. Employment has continued to rise throughout 2019, and the jobless rate has fallen to levels last seen in the 1970s. That's been complemented by an improvement in wage growth, which is now outpacing inflation. Usually, this would be a signal to think about raising rates, but there are other factors to consider.

Economic Payback

Economic growth is proving volatile this year, thanks in part to stockpiling by companies ahead of the original Brexit deadline at the end of March. After the expansion accelerated to 0.5% in the first quarter, the BOE anticipates zero growth in the three months through June.

Manufacturing shrank for a third month in July, partly because of the unwinding of stockpiling but also because of the “choke-hold of slower global economic growth” and “political uncertainty,” according to IHS Markit's survey of purchasing managers.

Read more: U.K. Factories Stuck in Worst Slump in Six Years on Brexit

While consumer spending is providing support for the economy, weak business investment has persisted. The latter could improve if a Brexit deal gives clarity to companies, though there's just three months left to secure that.

--With assistance from Harumi Ichikura, Paul Gordon and Andrew Atkinson.

To contact the reporter on this story: Olivia Konotey-Ahulu in London at okonoteyahul@bloomberg.net

To contact the editors responsible for this story: Fergal O'Brien at fobrien@bloomberg.net, Brian Swint

©2019 Bloomberg L.P.