Bank of England faces quandary as UK weathers early Brexit hit

October 5, 2016 8:29 AM EDT

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By William Schomberg and David Milliken

LONDON (Reuters) - The Bank of England, which signalled a few weeks ago that a fresh interest rate cut was likely next month, has been put on the spot by signs that Britain's economy has weathered the initial shock of the Brexit vote better than expected.

While the prospect of a rocky divorce from Europe means Britain may need further stimulus from the BoE at some point, a survey of the huge services sector released on Wednesday suggested the economy has so far avoided a sharp slowdown.

The survey added to other indicators that have undermined the view held by many private-sector economists until recently that Britain was heading for a recession after it voted to leave the European Union.

A senior BoE policymaker acknowledged the surprising resilience of the economy since the June referendum, while adding it was too soon to say what it meant for the longer term.

Ben Broadbent, the Bank's deputy governor for monetary policy, told investors to wait for the BoE's next policy meeting on Nov. 3, when it will give a quarterly update on the economy.

Other BoE policymakers have recently dropped hints they might not vote for a rate cut then.

"The wiser course is to wait for the November Inflation Report, which gives us a good opportunity to reflect more systematically on the news since August, and what it implies -- if anything -- for the medium-term outlook," Broadbent said.

In the short term, he said, the economy seemed to have been cushioned by still buoyant demand from domestic consumers, the quick boost to exporters from the plunge in the value of sterling, and the gentle impact so far on the housing market.

The Brexit effect on investment was likely to be "more insidious" as companies faced the prospect of a long wait for the outcome of Britain's attempts to negotiate a new trading relationship with the EU.

Broadbent said the impact of the vote on Britain's housing market might also take longer to come through.

Many investors fear Prime Minister Theresa May will favour a tough approach to reducing migration from the EU, reflecting one of the main factors behind Britain's "Leave" vote in June but putting at risk the ability of exporters to sell into European markets, which could hurt the economy's growth prospects.

Speaking at her party's annual conference on Wednesday, May also said that the BoE's emergency measures to boost the economy had created "some bad side-effects" and that the time had come for a new approach to spurring growth.

A spokeswoman for May later said decisions on quantitative easing remained a matter for the BoE.

‎"The change is that Theresa May will put her government at the service of those who have found themselves poorer as a result of monetary policy," the spokeswoman said.

Broadbent, in his speech, said the long-run fall in interest rates was a global phenomenon, not one led by the BoE.

CAUTION

The BoE cut rates to a record low of 0.25 percent in August and took other measures to help offset the Brexit shock.

In September, the Bank said most of its policymakers still expected to cut rates again before the end of 2016, unless there was a meaningful change to their view on the outlook.

RBC rates strategist Vatsala Datta said on Wednesday that investors are now pricing in only a roughly 15 percent chance of a cut in November, compared with almost 30 percent last week.

New rate-setter Michael Saunders said on Tuesday the economy was probably growing faster than the BoE forecast in August but that he had not decided how to vote because unemployment could fall further without pushing up inflation.

Last week, Deputy Governor Minouche Shafik said more stimulus was likely "at some point" to stop the Brexit slowdown from turning into something worse but the timing would depend on data over the coming weeks and months.

Mirroring the caution about the longer-term prospects for the economy, the International Monetary Fund on Tuesday lowered its forecast for British growth next year to 1.1 percent from 1.3 percent in July.

The value of the pound dipped below $1.27 for the first time since 1985 on Wednesday and gained little support from the unexpectedly upbeat Purchasing Managers' Index (PMI) release. [GBP/]

Compiler Markit said the services PMI, and sister surveys of manufacturing and construction, meant Britain's economy was probably growing at a quarterly rate of 0.3 percent. That is slower from 0.7 percent in the second quarter but a far cry from the recession predicted by many private economists as recently as August.

Finance minister Philip Hammond is also gauging the need for further stimulus as he prepares to deliver his first budget statement on Nov. 23.

(Additional reporting by Andy Bruce in London and Kylie MacLellan in Birmingham; Editing by Catherine Evans)



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