LONDON (Reuters Breakingviews) - For all its independence, the Bank of England is at the mercy of politicians. The central bank’s boss, Mark Carney, said on Thursday that UK interest rates may rise sooner and by a bit more than previously anticipated. But that assumes Britain’s exit from the European Union is smooth. If Prime Minister Theresa May fails to secure a transition deal in the next few months, the governor will have to backtrack.
The central bank is a bit more optimistic about how fast the economy will grow during the next three years. It sees inflation overshooting the official 2 percent target over that period, and expects wage growth to pick up. These are all perfectly good reasons for Carney to modify his guidance on when policy rates will rise from the current level of 0.5 percent. But as he admitted, the predictions are based on a big assumption: that Britain will secure an orderly divorce from the EU.
Concerns about the separation are already dampening business sentiment. Nominal investment was around 3-4 percent lower in the year to June 2017 than it would have been without Brexit-related uncertainty and the expectation that sales will be lower outside the EU, according to Bank of England estimates based on a monthly survey of senior executives. The disruption will be even bigger if May’s government fails to secure a transition agreement with other EU countries by the end of March - a year before Britain is scheduled to leave the bloc. In that case, businesses will be forced to prepare for the possibility of a messy Brexit in March 2019, rather than waiting until the end of 2020.
The level of uncertainty about whether May can clinch that accord is highlighted by Reuters polls of what economists think will happen to quarterly GDP growth. The difference between the highest and lowest prediction for the first and second quarter of 2018 is 0.7 percentage points. That’s more than double the gap for the first quarter of 2019, even though what happens further in the future normally involves a broader range of uncertainty.
Carney is not just any economic forecaster – he is after all able to change monetary policy and influence the outcome. But in this case, what he says about the future path of interest rates matters less than what the prime minister does.
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