BoE keeps interest rate on hold, warns of sharp sterling depreciation if UK leaves EU

The Bank of England’s Monetary Policy Committee (MPC) voted unanimously to keep the interest rate on hold at record low level of 0.5%, in line with expectations. The MPC also voted to keep the size of asset purchase programme unchanged at GBP 375 billion. The central bank is unlikely to have any serios talks on changes in policy until after the referendum in June. The BoE also updated its inflation and growth outlook; however, the forecasts are likely to be highly uncertain due to the EU referendum.

According to the central bank’s press release, there are growing “signs that uncertainty associated with the EU referendum has begun to weigh on activity. This is making the relationship between macroeconomic and financial indicators and underlying economic momentum harder to interpret at present. In the Committee’s latest projections, activity growth recovers later in the year, but to rates that are a little below their historical average. The May projection is conditioned on a path for Bank Rate implied by market rates and on continued UK membership of the European Union, including an assumption for the exchange rate consistent with that.”

The central bank has raised its cautions regarding the likelihood of negative impact of the UK exiting from the EU. Particularly, it emphasized at a possibility of the sterling declining sharply and consumers and businesses delaying purchases. If UK leaves the EU, the nation’s inflation will be higher and growth subdued.

If the UK stays in the EU, the central bank forecasts that the GBP will recover about half of the losses it witnessed in recent months. The central bank projects that the UK economy will grow 2% in 2016 and 2.3% in 2017 if the Brexit does not happen. The forecast is a bit weaker than the earlier projections of 2.2% and 2.4% growth in 2016 and 2017 respectively.

According to the BoE, if a Brexit takes place, it will impact capital inflows, result in a longer period of uncertainty, raise bank funding costs and risk premia, and risk financial stability. Meanwhile, the central bank’s new inflation report shows that the committee projects inflation to reach the target rate of 2% in mid-2018. However, it anticipates inflation to then surpass the target rate if it were to set policy on par with market projections.

If the UK votes to stay in the EU, the economy is likely to get rid of its recent weakness quite rapidly and the activity is expected to recover in H2 2016, said Nordea Bank in a research report.

“We stick to our forecast that the BoE will start hiking rates in late 2016. But the risk to this forecast remains skewed towards a later hike, with February 2017 as a good candidate”, added Nordea Bank.