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Bank of England warns about Brexit stagflation risks

Aegon UK’s Nick Dixon, said, however, that while expectations of looser monetary policy on the back of worries of the Brexit vote and declining growth may hold in the short term, “the two year picture indicates rising energy costs, higher US rates and lower sterling, which may trigger rising prices.  We could well be nearer than we think to the inflection point when both inflation and interest rates start to increase.”

This is supported by the MPC’s continued expectation that inflation’s medium term path is upwards, something by which many in the market remain unconvinced.

Part of the problem is that, as Carney himself said in his opening remarks: “The referendum makes describing the outlook for inflation more challenging than usual. That’s because some asset prices used to condition the Committee’s projections are likely to have been affected by market participants’ perceptions of its consequences.”

Indeed, the BoE attributes as much as 9% of sterling’s recent decline to Brexit uncertainty.

As Royal London Asset Management economist, Ian Kernohan said: “The Bank’s base case is for the UK to vote to remain in the EU, and on that assumption, the MPC is still signalling the next move in interest rates will be up, therefore markets’ interest rate expectations are too low.  

However, as Kernohan points out there has been little reaction to the news that the downgrades to growth forecasts have not fed through into a weaker inflation forecast.

Because, he said: “Investors know that as far as the Bank of England’s policy is concerned, the outcome of the referendum remains the big ‘known unknown’.”

And, while the Bank’s central case is for the effects of that uncertainty to work its way out of the system by the middle of next year should Britain vote to remain, it is still hard to judge how much of the current landscape is the result of the referendum and how much is actual underlying growth. And, as a result of that, the chance of policy mistakes is elevated.

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