Russell Lynch: Rate hikes look risky this year as UK stumbles in Brexit labyrinth

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DESPITE an effort to dodge the topic — a Christmas armistice if you like — there was no avoiding questions over the festive period on how Brexit would unfold in the next few weeks.

My stock reply was that when Cabinet ministers don’t even know what on Earth is going on, how should I? As we trudge with trepidation into the New Year, the Socratic dictum was never more apt: “To be uncertain is to be uncomfortable, but to be certain is to be ridiculous.”

There are so many variables with Brexit that forecasts become virtually impossible.

So the best approach is to strip it back to one of the few certainties in the process: that Theresa May’s deal has almost no chance of being passed by the House of Commons.

One bookmaker is offering winnings of just £2 on a £100 stake that her withdrawal agreement will be chucked out: as a racing certainty, it’s Red Rum and Desert Orchid rolled into one.

That takes us into the PM’s “uncharted territory”, with the only certainty (as of now, anyway) after that being the legal departure day on March 29. Which makes it look bizarre that most City forecasters, including the Bank of England, are basing their own predictions this year on a “smooth transition”. Unless the parliamentary arithmetic transforms itself within five days, that doesn’t look possible, whatever lifebelts are thrown by the EU to help a floundering May.

The consensus of City economists has at least one, and more likely two, interest rate rises from Threadneedle Street pencilled in for this year. That looks extremely ambitious. It’s almost as if number-crunchers have put their hands over their eyes and are praying for some Dick Barton-style “with one bound he was free” moment for May, who miraculously gets a deal over the line and keeps the economic benefits of EU membership for another two years. That can only explain the narrow range of the forecasts, with barely more than a percentage point separating the worst bear from the biggest bull. The range is smaller than forecasts for 2017, when Brexit was still two years away. 

Economists have been burnt by previous pessimism over Brexit and, given the dark clouds ahead, you can hardly blame them for herding together for fear of looking foolish. But the more realistic signals may be in the money markets, which are far less bullish. Overnight sterling markets show a roughly 60% chance of just one rate rise from the monetary policy committee this year. Swap rates used to price fixed-rate mortgages have also softened in recent weeks.

Looking at the possible scenarios, it’s easy to understand why. If, or almost certainly when, the deal fails, the UK will be in for unprecedented weeks of political convulsion. A formal confidence vote tabled by Labour in the Government looks a foregone conclusion. May should win it with the support of Brexiteers, who have pledged to rally round after their attempted coup; but if the only thing on the table is a no-deal Brexit, there’s also the outside possibility that pro-EU Tories resign the whip to vote against their own Government in the national interest. That leads to a general election — after another two weeks of delay.

May could take the initiative herself and call a second referendum, but Parliament looks unlikely to go gently into a no-deal. After all, 20 Tory rebels voted against it last night. Another democratic exercise looks more likely than not and it will take months rather than weeks, aided by a revocation or extension of Article 50 before B-Day. In short, it’s a horrendous political labyrinth and May will do well to get out of it without being devoured by a minotaur.

Any chance of the Bank of England pushing up interest rates while all this is going on is slim; albeit not as slim as a mooted hike in interest rates to 5.5% set out late last year in its scenario for a “disorderly” exit.

Climbing wage growth is the big worry for rate-setters at the moment as well as low unemployment, but we’ve got a housing market cooling rapidly, and price-sensitive consumers shying away from big ticket items. Underlying inflation is also down at 1.8%, which is hardly alarm-bells territory. Maybe the Bank could risk a rate rise in November if the dust settles, although I’d not be surprised at all to see the MPC sit on its hands all year. But who can say?

As Socrates said: “I know that I know nothing.” Even he wouldn’t get Brexit.

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January 10, 2019 |
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