Tuesday, July 5, 2016

BOE’s Carney to speak as Brexit puts squeeze on central banks

Brexit seen as forcing Fed to keep rates on hold until December

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BOE Gov. Mark Carney has hinted that more easing is coming this summer.
Since the Brexit referendum, analysts have been busy assessing the impact on economic and financial markets from the U.K.’s shock vote to leave the European Union. Their conclusion? Eurozone and U.K. economic growth will be hard hit in the next few years — and that will force central banks to take action.
Under heavy pressure to react to the June 23 vote, both the Bank of England and European Central Bank expected to provide more stimulus, and analysts believe they’ll deliver.
“Given the uncertainty and likely economic downturn, we expect the BOE to use its financial crises play book. That means ignoring sterling-driven inflation, quickly taking interest rates to, or close to, zero and subsequently restarting QE,” analysts at Bank of America Merrill Lynch said in a note Monday.
BOE Governor Mark Carney signaled last week that rate cuts and other easing measures are likely to come this summer. Its key interest rate currently stands at a record low of 0.5% and hasn’t been cut since March 2009.
But after the uncertainty following the referendum, a rate cut now seems inevitable. Analysts expect the U.K. central bank to slash its rates as early as its July 14 meeting, and then again in August, when it will also give an updated outlook on economic growth and inflation in its closely watched quarterly inflation report.
Investors will get more hints from Carney on Tuesday, when the bank’s Financial Stability Report comes out at 10:30 a.m. London time, or 5:30 a.m. Eastern Time, followed by a press conference at 11 a.m.
Read: Markets brace for Bank of England rate cuts after Brexit turmoil
U.K. seen sliding into recession
Concerns over the future of the U.K. economy post-Brexit have been a key topic since the referendum was announced in February. Since the ballot in June, GDP forecasts for the country have been consistently slashed.
B. of A. said it now expects three quarters of recession in the U.K., starting in the third quarter of 2016. It cut its GDP forecasts to growth of 1.4% in 2016 and 0.2% in 2017, down from previous forecasts of 2.5% for both. The bank also revised its 2017 eurozone GDP forecast down to 1.1%, from 1.6%.
Citigroup sees U.K. growth of 1.3% for 2016 and 0.9% for 2017, down from 1.7% and 2.1% respectively, while J.P. Morgan forecasts a slowdown in 2017 to 0.6%, from 1.1%.
Brexit to slow economic growth, J.P. Morgan says.
But the fallout from Brexit is unlikely to be contained just to Britain, and the ECB will have to step up easing as well, according to economists.
“After the Brexit shock, Europe is one step closer to a persistent 1% growth, 1% core-inflation economy,” the B. of A. analysts said.
The region can’t sustain those levels in the long run, either politically or socially, given its high unemployment rate and poor productivity development, they added.
“After the Brexit shock, Europe is one step closer to a persistent 1% growth, 1% core inflation economy.”
Bank of America Merrill Lynch
“This is a very unstable equilibrium, only sustainable because of the ECB backing. But we expect it to destabilize once [quantitative easing] is gone, absent any further policy innovations,” the analysts said.
“And we remain skeptical about those innovations.”
That doesn’t mean, however, that the ECB won’t introduce more easing to the eurozone economy, to soften the Brexit blow. The B. of A. analysts expect the central bank to bring forward its stimulus actions, and they see policy makers using their July 21 meeting to deliver “serious” hints of hard moves in September.
Investors may get a hint of what’s coming when ECB President Mario Draghi speaks in Frankfurt on Wednesday at 9 a.m. Central European Time, or 3 a.m. Eastern Time.
Further easing could come in the form of extending the ECB’s bond-buying program beyond March 2017. Governor Mario Draghi and team could also abandon the capital key, which determines how many bonds from each country it can buy under the QE program, they said.
Other investment banks — including Citigroup, J.P. Morgan and Deutsche Bank — agree that the ECB is likely to strike a more dovish tone at its July meeting, prompted by the Brexit vote.
Markets have already reacted strongly to the referendum outcome. The pound GBPUSD, -0.8503%  slid more than 10% against the dollar, while the Stoxx Europe 600 index SXXP, -1.26%  posted its biggest loss since 2008.
“If market pressures build, a frontloading of QE is possible. If spreads widen in a disorderly way, the ECB could choose to temporarily deviate from the QE capital key,” analysts at Deutsche Bank said in a note.
“There are non-negligible political costs with this, and other differential policy options may be easier,” they added. One option could be to offer another round of cheap loans to banks via targeted longer-term refinancing operations, or TLTROs.
Most investment banks don’t expect the ECB to further cut interest rates, after it yanked them lower at its March meeting.
Fed to stay dovish, too
The Brexit outcome is seen as also nudging monetary policy in the U.S. The Federal Reserve isn’t expected to cut rates or introduce more easing measures because of the vote, but its next rate hike is likely to be postponed because of the turmoil caused in financial markets.
Traders are currently not pricing in a rate increase this year, going by the CME Fed Watch Tool. Before the U.K. referendum, the fed funds rate was reflecting expectations for a rate hike in December.
“Questions about [U.S.] policy space and policy effectiveness are likely to remain on investors’ minds, as the risk of a Chinese slowdown, greater-than-expected fallout from Brexit and a number of others risks continue to threaten in” the second half of 2016, economists at Citigroup said in a note.
The Citi team expects one U.S. interest rate rise in 2016 and two in 2017. Minutes from the Fed’s meeting on June 14-15 are due on Wednesday at 2 p.m. Eastern Time. While the meeting took place ahead of the Brexit vote, it may still provide clues to the Fed policy makers’ thinking.

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