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BoE post mortem

Mark Carney has made perhaps the most dramatic intervention in the Brexit debate thus far, using the full might of the Bank of England to suggest that an exit from the EU would have dramatic consequences for the UK.

Bank of England
Source: Bloomberg

As expected we got a downgrade to growth forecasts, but somewhat surprisingly the bank left the inflation forecast unchanged, holding it at 2% for 2018. The bank argued that the UK’s exit from the EU would cause sterling to depreciate sharply, leading to higher import prices and inflation.

The bank added that this could require interest rates to rise. Brexiteers will condemn this as an overtly political step, but the BoE can hardly be blamed for having a view on what could be the defining event for the UK for years to come.

Notably the BoE’s forecasts were based on the idea that there would be one (yes, just one) 25 point rise by the second quarter of 2019. Considering that Mark Carney has warned about a rate increase for years now, this salient point marks perhaps an acknowledgement that even thinking about tightening policy is a fool’s errand.

In addition, Carney noted that the bank would look to cut rates before using unconventional policy tools, a fact which the market has overlooked thus far but will likely assume increased importance in coming days.

In market reaction, the news has been enough to send GBP/USD rocketing, presumably because of the lack of any dovish caucus on the MPC and the unchanged growth forecasts. Markets have seemingly adjusted to the idea that a UK exit is at least a possibility, albeit one whose impact is difficult to calculate.

GBP/USD’s firm push through $1.45 should suggest that a new leg higher has begun here, having firmly built a base off the $1.44 level earlier in the week.

The next target becomes the $1.4660 area, where gains petered out at the beginning of the month. This level was also crucial at the beginning of February, with a close above here paving the way to the 200-day simple moving average (currently $1.4832).

EUR/GBP meanwhile has nosedived, with the likelihood being that the short-lived bounce of late April, followed by the consolidation of early May, is about to give way to a fresh downward move. In this case, downside targets to begin with would sit in the area of 77.42p and then 76.95p.

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