BoE to normalise interest rates contingent on ‘smooth’ Brexit

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Interest rates will be able to rise towards more normal levels over the next three years if Theresa May negotiates a “smooth” Brexit, the Bank of England said on Thursday as it released forecasts suggesting the recent economic slowdown will be temporary.

But in a warning to the prime minister within weeks of the general election, the central bank made it clear that its sanguine forecasts depended on the prime minister coming back from Brussels with a deal that ensured companies did not have to make sharp adjustments as Britain leaves the EU.

Presenting its quarterly inflation report, the BoE said the positive outlook for growth recovering and inflation falling back towards the 2 per cent target next year was dependent on big assumptions it made in these pre-election forecasts.

At the May meeting, the central bank’s Monetary Policy Committee voted 7-1 in favour of keeping interest rates at the historic low of 0.25 per cent and maintaining the level of money pumped into the economy under the quantitative easing scheme at £435bn.

Kristin Forbes, an external committee member, voted for an immediate interest rate rise but she was not joined in wanting to tighten policy by other members such as Michael Saunders, who had given a hawkish speech within the past month.

In its quarterly inflation report, the bank’s Monetary Policy Committee accepted it had been too optimistic about economic performance in the first half of 2017 and the weak 0.3 per cent growth rate in the first three months of the year was likely to extend into the second quarter.

But it expected the squeeze on household incomes from higher inflation to ease later in the year and a recovery to be aided by higher business investment and exports.

The BoE’s forecasts were little changed from February. In the near term, the bank expects a little more inflation with prices rising faster than wages in 2017, intensifying the squeeze on household incomes, but consumption weakness is expected to improve during 2018 as inflation falls back and wages rise.

The 2017 growth forecast has been revised down only from 2 per cent to 1.9 per cent.

In 2018 and 2019 the central forecast is revised up by the same amount, reflecting sterling’s recent strength leading to lower import prices and inflation, so easing the squeeze on incomes.

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