BoE caught between Brexit headwinds and rising inflation - HSBC

Analysts at HSBC suggest that with falling unemployment and Brexit headwinds still looming, it’s going to be hard for the BoE to go ahead with the rate rise anytime soon.

Key Quotes

“Indeed, the UK faces the unique challenge of negotiating its exit from the EU. Following the surprise result of the 8 June election, when Prime Minister Theresa May failed to win a majority, the mood music has changed a bit, with voices calling for a softer Brexit getting louder. In theory, this points to a diminishing risk of a ‘cliff edge Brexit’. But time is short, tensions run high and the parliamentary arithmetic is very tricky.  So there is still a non-negligible chance that the UK ends up leaving the EU with no deal and no transition arrangement.”

“Against this backdrop, we think the UK faces substantial headwinds this year – on top of those that are already in play. The fall in sterling since November 2015 has seen inflation overtake nominal wage growth, leaving consumers squeezed. We now think inflation will stay more elevated for longer. The housing market is also showing signs of weakness. Given the political risks around Brexit and a weakened government, we find it hard to believe that now is the time for a resurgence in investment in the UK. While we think growth picked up from 0.2% q-o-q in Q1 to 0.4% in Q2, this is below the 0.6% average quarterly growth seen over 2013-2016. We expect growth to remain subdued throughout this year and next.”

“Our outlook is a bit more cautious than the Bank of England’s. The UK's MPC surprised observers at its 15 June policy meeting, when three of its eight members voted for an immediate rate rise.  With unemployment falling, they cited concerns that an erosion of labour market slack might start pushing underlying inflation uncomfortably high.  This followed the May Inflation Report, which laid out a fairly upbeat set of assumptions: a smooth Brexit; no further slowdown in growth from the Q1 2017 low; no rise in unemployment; a pick-up in business investment to above its pre-crisis average; a meaningful increase in wage growth and – at the end of its forecast period – a rise in domestically generated inflation. We agree, that in that scenario, rates would probably rise. However, for us, there are too many ifs.  And our assessment that the UK consumer cycle has turned means labour market slack could open up again.  So we retain our view that rates will stay on hold through 2018 at least.”