May’s Brexit Transition Push May Increase Chance of BOE Hike

Theresa May’s speech outlining a possible transition period after Brexit may make it easier for the Bank of England to raise interest rates as soon as November.

While the prime minister largely skimmed over the economy in her highly anticipated remarks on Friday, she proposed for the first time that there be a two-year extension of the status quo as part of the U.K.’s exit from the European Union. That would mean Britain would be less likely to suffer the cliff-edge scenario of dropping out of the bloc with no deal.

Crucially, the BOE assumes a smooth Brexit for its economic forecasts. It will update those projections Nov. 2, when there’s a chance it may also increase interest rates for the first time in more than a decade. While May’s speech in Florence, Italy didn’t go as far as might have been expected given the buildup, it did provide some new details on transition and payments to the EU.

“The real crunch will come next month when EU leaders judge whether sufficient progress has been made in the talks to begin trade negotiations,” said Dan Hanson and Jamie Murray, economists at Bloomberg Intelligence in London. “May’s conciliatory tone was a step in the right direction. The Bank of England is likely to see her remarks as removing another potential barrier to lifting interest rates in November.”

In general, the response to May’s speech was that she may not have gone far enough. The pound declined as she spoke and was down 0.5 percent at $1.3513 as of 4:40 p.m. in London.

JPMorgan Chase & Co. economist Malcolm Barr said while the U.K. “has taken a limited step toward a more pragmatic stance on the initial legal exit from the EU that emerged over the summer, its position appears to remain deeply conflicted.”

James Knightley, at ING, said May’s speech was “conciliatory yet thin on details.” But while the cliff-edge possibility hasn’t disappeared, the chance of a transition deal — which would extend current EU-U.K. arrangements for 3 1/2 years — may encourage investment.

“If there is a little more business optimism and this translates into stronger economic activity, this could see the Bank of England becoming more inclined to raise interest rates,” he said.
Source: Bloomberg