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Market Wire
Bank of England Retreats From Tightening Plans

Karl Schamotta February 7, 2019

The Bank of England has joined its counterparts in Australia, Canada and the United States in sharply downgrading the economic outlook and retreating from its monetary tightening plans. In a decision released this morning, the Bank slashed expected 2019 growth to 1.2 percent, with “softer activity abroad and the greater effects from Brexit uncertainties at home” helping to weaken activity. Officials had previously expected the economy to expand 1.7 percent this year.

In voting unanimously to hold the benchmark lending rate at 0.75 percent, the Monetary Policy Committee suggested that the risk of an inflationary overshoot had fallen, with only one quarter-point interest rate hike needed to keep price increases contained near its two-percent target over the next three years.

Officials acknowledged a significant degree of uncertainty with respect to ongoing divorce proceedings, saying, “The economic outlook will continue to depend significantly on the nature of EU withdrawal, in particular: the new trading arrangements between the European Union and the United Kingdom; whether the transition to them is abrupt or smooth; and how households, businesses and financial markets respond”.

The pound is trading on a modestly-weaker footing in response, rebounding slightly after falling roughly 0.7 percent in the minutes after the statement was released.

In a press conference after the decision, Governor Mark Carney said that households and businesses are “increasingly” concerned about Brexit, and that the United Kingdom’s growth rate was 1.5 percent below levels that had been expected in June 2016. When asked whether the probability of a no-deal Brexit had gone up, he responded, “I think it is a statement of the obvious” – but suggested that a ‘soft’ exit remains the Bank’s base case. If the process is concluded with minimal disruption, policymakers expect firms to hire and invest, wages and prices to rise, and the economy to grow.

The dollar is holding onto its recent gains after the US Department of Labor reported that 19,000 fewer people applied for unemployment benefits last week. 234,000 initial claims were submitted – slightly above the 221,000 expected – and the four-week moving average increased modestly to 224,750. Strength in America’s jobs market continues to substantially offset weakness evident in other areas of the economy – supporting the underlying growth differentials that have kept the greenback aloft for almost two years.

Bottom Line: In tapping the monetary brakes, the Old Lady of Threadneedle Street has become the latest in a series of central banks to reverse the “quantitative tightening” theme that was once expected to dominate financial markets through 2019. With liquidity conditions improving in China, Europe, the United States, and a bevy of smaller economies, high-risk currencies and asset classes are gaining some breathing room – and a return to “normal” in financial markets is looking distant once again.

Karl Schamotta
Chief Market Strategist
kschamotta@cambridgefx.com
@vsualst

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