LONDON – There can rarely have been a more complicated time to set interest rates for the U.K. economy.
While high inflation, low unemployment and stable growth would usually prompt the Bank of England to raise interest rates again soon, concerns over Brexit are likely to stay the hand of its Monetary Policy Committee, whose decision is due Thursday.
"Uncertainty over how Brexit talks will pan out means that the MPC won't want to make a strong commitment regarding the timing of the next rate hike," said Samuel Tombs, chief U.K. economist at Pantheon Macroeconomics.
With the next stage in the Brexit discussions with the European Union due to start soon, there's a sense of confusion over what Britain's exit from the bloc in a little over a year's time will entail. Chief among the concerns is the terms of a transition period that Britain wants in place after it is due to leave in March 2019 in order to smooth out its exit and give it time to adjust to a new economic relationship with the EU.
Bank of England Governor Mark Carney has said that the outlines of the transition deal should be agreed upon by the end of this quarter so that firms across sectors — particularly in the crucial financial services industry — can start planning. Doing so, he has said, will limit the risks of a shock on Brexit day: "The sooner the better."
Despite a lack of clarity over Britain's economic outlook after March 2019 and whether firms will continue to have access to the European tariff-less single market, the British economy proved last year to be more resilient than many had forecast. That has emboldened many Brexit backers to discredit warnings about the future. The Bank of England itself was one of the more high-profile forecasters to get it badly wrong in the run-up to the Brexit referendum in June 2016, warning that a vote in favor of Brexit could lead to recession.
There's been no recession — not even close — partly because the fall in the pound helped boost exports, particularly to the 19-country eurozone, which is currently in the midst of its strongest upturn in a decade.
In the final three months of 2017, the British economy grew by a quarterly rate of 0.5 percent, a better than expected outturn that means it expanded by 1.8 percent overall last year. While slower than the neighboring eurozone or the U.S., it's still a healthy pace.
As a result, many in financial markets are predicting the Bank of England will raise rates again as soon as May, especially if an agreement on a Brexit transition period is secured.
Last November, the Bank of England hiked its main interest rate by a quarter percentage point to 0.5 percent, its first increase in a decade, to bring inflation down. It hinted of more to come. Price increases became more acute after the Brexit vote as the plunge in the value of the pound raised import costs, notably of energy and food. Inflation hit an annual rate of 3.1 percent in November, from around 0.5 percent at the time of the Brexit vote.
Though above-target inflation is likely to remain a key feature during this week's interest rate deliberations, it's not expected to result in another hike. Carney will likely buy time by stating that the recent firming of the pound to over $1.40 as well as the softening in the housing market will help the bank get inflation back toward its target rate of 2 percent.
The biggest complication for rate-setters is Brexit-related. With the minority governing Conservative Party divided between those who want a clear split with the EU that will allow the country to carve out trade deals around the world, and those advocating only modest changes in the relationship with Britain's biggest trading partner, uncertainty is flaring up once again.
On Monday, a closely watched survey of business activity in the manufacturing, construction and services sectors fell to its lowest level since August 2016, the immediate aftermath of the Brexit vote.
"Brexit continues to be mentioned as a source of uncertainty, and that's likely to persist over coming months until there is greater clarity on the future trading relationship," said James Smith, developed markets economist at ING.
Should some certainty re-emerge by the springtime, in the form of a Brexit transition deal, the case for a rate hike would grow.
But the current infighting in the British government suggests we're nowhere near there yet.