Williams said a ‘Brexit,’ would see long-term conventional gilts benefit initially from the perceived hit to growth but this could be short lived, given that more than one third is backed by international investors sensitive to currency and ratings risk.
In this scenario Williams said it is ‘not beyond reason’ that a hit to growth resulting from a Brexit may in extremis need the Bank of England to again be the biggest sponsor of gilts, by reactivating QE.
“The UK’s EU referendum by the end of 2017 will be the big ‘known unknown’ for UK assets,” Williams said.
“Logic suggests the unlikelihood of the UK wanting to risk weaker ties with its main trading partner, foreign direct investment forgone, and a diluted relationship with the US. But, the uncertainty leading up to 2017 will doubtless at some stage take the shine off the pound.”
In the meantime however it is ‘back to business’ for the Bank with May’s election and the oil price fall out of the way, Williams noted.
“The economic recovery is broadening, yet the MPC’s adherence to a 2% CPI inflation target makes a rate hike difficult before 2016,” he added.
“Our UK inflation projections suggest that, with oil’s base-effect from June, and inflation driven by the less exchange-rate-sensitive services sector (an underlying 2.25%yoy) the CPI could drift back to target as early as next spring,” Williams continued. “The RPI meantime should be supported by house prices. A spring 2016 hike would end seven years of keeping Bank rate at a record low 0.5%. Oil’s base-effect should likewise lift the US CPI, though the Fed’s dual mandate, focussing explicitly on job creation, should allow it to move earlier, in H2 2015.”
