Carney’s Brexit Dilemma

“Brexit, Brexit, Brexit!” – say it’s name three times in the mirror, and hope for it to go away.

Well, that’s probably what Bank of England Governor, Mark Carney would want. More than half a year since Britain’s vote to leave the EU, and the shadow of Brexit still looms large for the UK economy and political landscape.

Carney now seems caught between Scylla and Charybdis. Widley condemned by the Remain camp for acting too soon in August 2016 to reduce the Bank of England’s base rate to 0.25%, he now stands to be accused of not reacting quick enough to the rising inflation issue.

For anyone who was watching or listening to PM Theresa May’s address regarding Brexit on the 17th of January, the below chart will look familiar.

 

GBP Price Action 17 Jan 2017
GBP Price Action 17 Jan 2017

Source:tradingview.com

 

To put this chart in some context, towards the tail end of the prior week, elements of PM Theresa May’s speech was leaked, causing markets to further price in the possibility of a hard Brexit. This sentiment carried over into the open of the Asia session on the preceding Monday (16th), resulting in the pound/dollar cross trading as low as 1.19875 – and raising fears of a retest of the October Algo spike low towards 1.16. However most likely due to lower volume on account of the US Martin Luther King holiday, the pound ranged and failed to move lower. Tuesday saw the onset of inflation figures delivering an increase of 1.6% vs. the expected 1.4% – and in a sign of what some may consider insider dealing, cable rallied massively in advance of the data from 1.20400 in the Asia session to 1.21880 by 9:30 GMT.

Just looking at the chart below, it doesn’t require a genius analyst to see the effect Brexit has had on consumer prices already.

 

2016 UK inflation rate
2016 UK inflation rate

Source:tradingview.com

And then came the main event, PM Theresa May’s speech despite being partially leaked, delivered some surprises. While the market had priced in hard Brexit rhetoric, May delivered a mostly balanced speech, and importantly for Cable, indicating that the conditions under which Britain will leave the EU will be put to vote. The markets had not priced this vital piece of information in, and cable rallied for the better part of the day. The key take away here is that the pound is still massively politically sensitive

So, what to do?

Inflation is rising, on account of the currency, and at its current rate there is a risk of inflation overshooting the BOE’s target rate of 2%. Let’s not forget, that during August, the BOE also implemented a large chunk of QE, to the tune of some £435 billion.

And so Carney’s dilemma is this: Can he risk a rise in interest rates to curb an overshoot in inflation, when the underlying causes for this inflation are not from rapid economic growth, but more from a heavily devalued currency?

There is no doubt that the pound’s current value has made the UK “cheaper” for some investors, but the uncertainty and political sensitivity of the Brexit issue has not made the UK more secure, and long term investment is still a concern – especially in the financial and property sectors. Raising interest rates too soon could stifle the easy credit many smaller companies have been relying on, but leaving it to overshoot could start to cause widespread consumer issues. After all, do we really need another Marmite Gate??

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