MPC won’t wait long if no deal avoided

The latest labour market data suggests that the Monetary Policy Committee could quickly turn hawkish if a no deal Brexit is avoided. In its November Inflation Report, the Bank of England forecast inflation to exceed its target throughout the next two years even if it raises interest rates by 50bps over the same period. And the latest pay growth figures suggest that inflationary pressures are building more quickly than it anticipated. Headline annual pay growth hit 3.3% in October, well above the 2¾% expected by the Bank. But concerns that there will be a no deal Brexit mean that investors currently expect just one interest rate hike over the next two years. We suspect that if a no deal Brexit is avoided, investors would almost certainly revise up their interest rate expectations closer to our forecast that Bank Rate will rise to 2% by the end of 2020. This would probably cause the pound to reverse much of its depreciation since 2015, rising to $1.45, but cause a sharp sell-off in gilts.