Pivotal weeks ahead. The fog of uncertainty. BoE Post-Meeting Comment. Summary. RaboResearch. Marketing communication 07 February 2019

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1 Implied probability of hike Marketing communication 07 February 2019 Pivotal weeks ahead BoE Post-Meeting Comment RaboResearch Global Economics & Markets mr.rabobank.com Stefan Koopman Market Economist Summary The MPC left its policy settings unchanged at the February meeting in a 9-0 vote. The MPC slashed its 2019 GDP forecast to 1.2% from 1.7%. This is slightly above our own forecast of 1.1%, but below the EC s forecast of 1.3%. Even though these forecasts seem to be in agreement, the reality is that the UK s economic outlook remains extremely uncertain. We argued that a rate hike would have been on the cards if it wasn t for Brexit uncertainties. The MPC seems to agree: a box study in the Inflation Report suggests that GDP growth would have been 1.6% this year and 2.2% next year if political uncertainty was to be reduced. But these would haves don t buy you anything: in the fog of so much Brexit uncertainty, the Bank s outlook is leaving us none the wiser about a potential rate hike in the coming months. If there is no sign of any material progress on Brexit in the next few weeks, leaving the MPC without the clarity it so much needs, we may want to re-visit our forecast of a rate hike in May. The next weeks will prove pivotal. The fog of uncertainty The Bank of England MPC kept its key interest rate unchanged at 0.75%, left its asset-purchase plans untouched, and did all this unanimously. This was entirely as expected. The forward guidance was unchanged as well, and still reads as follows: The Committee judges that, were the economy to develop broadly in line with its Inflation Report projections, an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent, would be appropriate to return inflation sustainably to the 2% target at a conventional horizon. So, no changes on the policy front. What about the outlook? Well, the MPC did slash its GDP forecasts. Most prominently, the projection for 2019 was revised down from 1.7% to 1.2%. This is slightly above our own forecast of 1.1%, but below the European Commission s forecast of 1.3% (released earlier today). The MPC noted that Brexit uncertainties have intensified and that this is having an impact on consumer spending, particularly on big tickets, and on business investment. Figure 1: UK GDP slows down into % 1.20% 0.80% 0.40% Figure 2: Markets don t believe the MPC 70% 60% 50% 40% 30% 20% 10% 0% 0.00% Rabo EC IMF OBR BOE OECD 2019 UK GDP Forecast May 2019 Aug-19 Source: Macrobond, Bloomberg Source: Macrobond, Bloomberg 1/6 RaboResearch Pivotal weeks ahead , 16:50

2 The outlook for business investment, which has already been falling for three quarters, was cut significantly. The MPC now expects investment to shrink -2.75% in 2019, while a 2% rise was pencilled in three months ago. In his press conference, Governor Carney highlighted in particular the proximity to the Brexit date that leads businesses to postpone critical decisions until there is more clarity about the future relationship between the UK and the EU. Moreover, a box study in the Inflation Report even suggests that growth would have been 1.6% this year and 2.2% next year if this uncertainty was to be reduced. Taking the glass half-full approach, the implication is that the MPC believes that if we do get clarity there is latent demand to be released. This suggests some upside risk to their forecasts if Brexit clarity arrives sooner than anticipated, and if the latest months weakness in global growth proves to be less persistent than thought. Meanwhile, the sharp reduction in business investment has also reduced the MPC s estimate of supply growth from 1.5% to a little below 1.5%. The MPC also refers to this rate as the speed limit of the UK economy. In other words, the MPC doesn't need to see a period of strong growth before believing that higher interest rates are required to reduce inflationary pressures. This brings us to the MPC s forecasts, which are summarised below and could change radically if there s more certainty about the type of Brexit the UK economy will have to endure. Nonetheless, the recent slowdown and the elevated Brexit uncertainties lead the MPC to believe that there is a small margin of excess capacity to emerge this year, but that this will reverse later into The relatively strong outlook for the second half of the MPC s forecast period serves as another reminder that the Committee remains keen on hiking interest rates at a gradual pace. We would agree, but it will be very gradual indeed! Finally, it is worth pointing out that short sterlings rallied a few bps after the release of the forecasts, as there is just 40 bps worth of Bank rate hikes embedded in these forecasts rather than the 65 bps in November. However, please note that this rate path is fully derived from forward rates (i.e. any conclusions about this are self-fulfilling). Table 1: MPC Forecast summary 2019Q1 2020Q1 2021Q1 2022Q1 GDP 1.5% (1.8%) 1.3% (1.7%) 1.7% (1.7%) 2.0% CPI inflation 1.8% (2.2%) 2.3% (2.4%) 2.1% (2.1%) 2.1% Unemployment rate 3.9% (3.9%) 4.1% (3.9%) 4.1% (3.9%) 3.8% Excess supply (-)/demand(+) Bank rate 0.7 (0.8) 0.9 (1.1) 1.0 (1.3) 1.1 Source: Bank of England February 2019 Inflation Report, figures between parentheses are from the previous report Pivotal weeks ahead Over the course of the next week or so, it should become clear whether there is a real chance that May stands a good chance of winning a compromise with the EU that will be sufficient for her to push her amended Withdrawal Agreement through parliament. Only then will UK businesses be able to abandon their last minute plans for a no deal Brexit and reboot spending on capital investments; only then will the Bank of England MPC and its staff have a proper idea on what to expect going forward. As it is our central view that a soft Brexit preceded by a transition period is still the most likely outcome, and that EUR/GBP will settle in the area in the months ahead, we are reluctant to drop our call that the MPC wants to raise rates by May. But Brexit uncertainties are muddying the waters and will continue doing so. This forced the MPC to stand pat at this week s meeting and if uncertainties do persist due to an extension of Article 50 without the prospect of an immediate deal, it will force the MPC to stand pat at the May meeting as well. We do however expect the MPC to support the currency by appearing hawkish, making sure that investors keep the possibility of a future rate hike in the forefront of their minds. 2/6 RaboResearch Pivotal weeks ahead :50

3 RaboResearch Global Economics & Markets mr.rabobank.com Global Head Jan Lambregts Macro Strategy Europe Elwin de Groot Head of Macro Strategy Eurozone, ECB Stefan Koopman Market Economist Eurozone Teeuwe Mevissen Senior Market Economist Eurozone Bas van Geffen Quantitative Analyst ECB Wim Boonstra Senior Advisor Germany Ester Barendregt France Alexandra Dumitru Economist UK, Ireland Americas Philip Marey United States, Fed Maartje Wijffelaars Italy, Spain, Portugal, Greece Hugo Erken United States Koen Verbruggen Economist Eurozone Koen.Verbruggen@Rabobank.nl Christian Lawrence Canada, Mexico Christian.Lawrence@Rabobank.com Mauricio Oreng Brazil Mauricio.Oreng@Rabobank.com Asia-Pacific Michael Every Asia, Australia, New Zealand Michael.Every@Rabobank.com Björn Giesbergen Economist China, Japan Bjorn.Giesbergen@Rabobank.nl Hugo Erken India Hugo.Erken@Rabobank.nl FX Strategy Jane Foley Head of FX Strategy G10 FX Jane.Foley@Rabobank.com Piotr Matys FX Strategist Central & Eastern Europe FX Piotr.Matys@Rabobank.com Christian Lawrence LatAm FX Christian.Lawrence@Rabobank.com 3/6 RaboResearch Pivotal weeks ahead :50

4 Rates Strategy Richard McGuire Head of Rates Strategy Lyn Graham-Taylor Senior Rates Strategist Matt Cairns Senior SSA Strategist Credit Strategy & Regulation Ruben van Leeuwen Head of Credit Strategy ABS, Covered Bonds Vaclav Vacikar Analyst Financials Hyung-Ja de Zeeuw Senior Strategist Corporates Bas van Zanden Senior Analyst Pension funds, Regulation Cas Bonsema Analyst ABS Energy Markets Ryan Fitzmaurice Energy Strategist Agri Commodity Markets Stefan Vogel Head of ACMR Carlos Mera Senior Commodity Analyst Charles Clack Commodity Analyst Michael Magdovitz Commodity Analyst /6 RaboResearch Pivotal weeks ahead :50

5 Client coverage Wholesale Corporate Clients Martijn Sorber Global Head Hans Deusing Netherlands David Kane Europe Neil Williamson North America David Teakle Australia, New Zealand David.Teakle@Rabobank.com Ethan Sheng Asia Ethan.Sheng@Rabobank.com Ricardo Rosa Brazil Ricardo.Rosa@Rabobank.com Financial Institutions Eddie Villiers Global Head Eddie.Villiers@Rabobank.com Roeland Bronsveld Benelux Roeland.Bronsveld@Rabobank.com Krishna Nayak Germany, Austria, CEE Krishna.Nayak@Rabobank.com Philippe Macart France Philippe.Macart@Rabobank.com Mauro Giachero Italy Mauro.Giachero@Rabobank.com Martin Best UK, Scandinavia, Middle East Martin.Best@Rabobank.com Paul Duddy USA Paul.Duddy@Rabobank.com Wouter Eijsvogel Treasury Sales Europe Wouter.Eijsvogel@Rabobank.com David Pye Central Banks David.Pye@Rabobank.com Capital Markets Herald Top Global Head of Capital Markets Herald.Top@Rabobank.com Nader Pasdar Capital Markets USA Nader.Pasdar@Rabobank.com Adam Wotton Capital Markets Asia Adam.Wotton@Rabobank.com Willem Kröner Global Head of Equity Capital Markets Willem.Kroner@Rabobank.com Crispijn Kooijmans DCM FIs & SSAs Crispijn.Kooijmans@Rabobank.com Bjorn Alink DCM Securitisation & Covered Bonds Bjorn.Alink@Rabobank.com Othmar ter Waarbeek DCM Corporate Bonds Othmar.ter.Waarbeek@Rabobank.com Joris Reijnders DCM Corporate Loans Joris.Reijnders@Rabobank.com Brian Percival DCM Leveraged Finance Brian.Percival@Rabobank.com 5/6 RaboResearch Pivotal weeks ahead :50

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