What will Brexit do to interest rates?

The EU Referendum has stirred up real passion and the leave result has created major economic uncertainty and political turmoil. Some are vehemently voicing demands for a second Referendum with one MP even suggesting that the Referendum result should be ignored by Parliament.

The extent to which the leave will happen is also up for debate. What will be the eventual relationship with the EU? what sort of trade deals can be negotiated? how long will it take to get them? No one knows when we will get back to ?normal? or indeed what the new normal will be.Our Political team accurately predicted the EU Ref result and this level of accuracy is something Opinium have become famous for over the years. Our research teams are currently supporting a number of clients with insight and intelligence as they navigate this uncertain period.There are a number of moving elements contributing to the ongoing instability.Putting aside the political uncertainty, there are serious question marks about the extent and timing of:? EU withdrawal? future trade deals? domicile of multinational companies? Sterling foreign exchange rates? employment security? inward investment? future economic growth.But what effect will all this uncertainty have on interest rates?The Bank of England?s Monetary Policy objective is to maintain price stability and to support the economic policy of the government. It formulates monetary policy and is tasked with achieving the inflation target (it is charged with keeping the Consumer Prices Index inflation rate between 1% and 3% but centered on 2%). Its primary tools for doing so include setting the Bank Rate, foreign exchange intervention and varying the volume of asset purchases financed by the issuance of bank reserves.In the immediate aftermath of the exit result, Mark Carney, governor of the Bank of England, sought to calm the markets by saying that, to support the functioning of markets, the Bank of England is ready to provide more than £250bn of additional funds through its normal facilities. It is also able to provide substantial liquidity in foreign currency. The following week Mark Carney said ?In my view, and I am not pre-judging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer.?Classically, if there?s a recession ? and we don?t yet know whether there will be – interest rates tend to get reduced. However, if the value of Sterling falls, then the Monetary Policy Committee (MPC) might choose to increase interest rates in order to support Sterling and attract foreign investors seeking higher returns. These are conflicting pressures but the Treasury is reliant on foreign money to finance the massive current account deficit.On the morning of the Referendum result, Sterling fell to its lowest level against the US Dollar for 31 years. HSBC is predicting that a Pound will be worth US$1.20 at the end of 2016 which would represent a decline of around 20% from the levels that prevailed on the day of the referendum, but is a fall of only about 15% from the rate at the time when the referendum was called in February 2016. HSBC also forecast that a Euro will cost 92 pence by the end of the year.The fall in Sterling, which will make imports more expensive, could increase inflation. This creates something of a quandary for the MPC as it may well need to reduce the Bank Rate to boost the economy at a time that inflationary pressure would normally dictate a Bank Rate increase.The Bank Rate has been 0.5% since March 2009 and market expectations are that it will get reduced soon with some commentators expecting the Bank Rate to be cut to 0%. Robert Wood and Gilles Moec, economists at Bank of America Merrill Lynch say that ?We expect the Bank of England to follow the financial crisis template: make liquidity easily available, ignore the one-off inflation shock from sterling and ease policy. We expect for them to cut interest rates 50bp (to 0%) at their July 14 policy meeting. We also expect the BoE to relaunch Quantitative Easing with a £50bn salvo.?Swap rates have fallen since the Referendum. At the time of writing, the Bank of England?s overnight indexed swap forward curve, which portrays what banks charge each other for overnight lending, shows a rate of 0.10% for contracts which mature in December and 0.45% in five years? time.Sentiment can change quickly ? at the beginning of 2016 markets were penciling in a Bank Rate increase in August ? so, while there?s no certainty in future Bank Rate predictions, an imminent cut is expected. As David Tinsley, UK economist at UBS puts it, Brexit means ?sharply lower growth, a large drop in the Pound, and further easing from the Bank of England.?We live in uncertain times.