UBS: Déjà vu all over again

Consistent with that, the MPC confirmed the recently completed series of Gilt purchases conducted as an extension of Quantitative Easing (QE) will not be continued at this time 2017 GDP now forecast to be +2.0%, 2018 revised up fractionally to 1.6% For the second quarter in a row, the BoE acknowledged that growth in the intervening period had been more robust than anticipated. Due to a combination of recent domestic fiscal easing, firmer momentum in global activity, higher global equity prices, and more supportive credit conditions for households in particular, the MPC revised its forecast for GDP in 2017 from 1.4% to 2.0%. Growth in 2018 is expected to be 1.6% (up from 1.5%), and in 2019 1.7%.

CPI forecasts unchanged as higher market rates offset recent stronger growth

There was little change to median CPI projections over the forecast horizon. The potential impact from the improved GDP forecast was offset by the recent appreciation of sterling and the rise in market interest rates in the first month of 2017. The MPC lowered its estimate of the equilibrium unemployment rate from 5.0% to 4.5%, increasing the likelihood of subdued earnings under current labour market dynamics, and by extension raising the risk that accelerating inflation will squeeze real wages. 

Brighter near-term outlook still clouded by EU exit-related concerns

The press conference that followed the publication of the QIR was notable for its repeated references to the forthcoming two-year EU exit process, which after yesterday's vote in the House of Commons looks ever more likely to begin within the next two months. The Governor noted that this journey is "really just beginning", highlighting that the events of the coming months could cause a sharp deviation in the anticipated evolution of growth, inflation, labour market dynamics, and the currency.

Weaker consumption and investment to tilt the MPC back to an easing bias

A key determinant of the MPC's assessment of the outlook over the coming months will be the extent to which inflation accelerates – particularly at the consumer level – and whether that acceleration is matched in the pace of average earnings. If wages do strengthen materially, the MPC will warn of a need to tighten policy in response, whereas if (as we expect) they fail to do so as companies enact more defensive investment plans, concerns of a significant squeeze on real earnings will mount, and raise the possibility that the MPC may need to try and ease monetary conditions to offset the potential hit to consumption such a squeeze will exert. The resultant growing speculation of a return of QE would support our expectation that Gilts are set to outperform their US and core Eurozone equivalents.

Sterling downdraft set to resume as EU exit and current account deficit weigh

The decision is consistent with our bearish sterling view, as the market expected a shift to a more hawkish stance that failed to materialise. Risks with regard to near-term activity are arguably skewed to the downside from here. We expect post-referendum resilience to be tested in a more lasting manner as EU exit negotiations get under way shortly. We think risks are skewed towards additional policy easing in the coming months, which should weigh on sterling. Lastly, as we have argued repeatedly, the main vulnerability of the UK economy lies in its (still) large current account deficit. We expect the rebalancing of the external sector to be the main medium-term driver of the currency and it could bring EUR/GBP closer to our end-17 target of parity.

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