If there is one group more deserving of pity than Bank of England policymakers it is those investors who have to decide whether to hold sterling assets.
Both groups face forces beyond their control and arguably their comprehension and neither can dodge the issue.
The pound surged and British stocks whipsawed, depending on the currencies in which they earn their revenues, after Britain’s High Court on Thursday ruled that Parliament must vote on the measure triggering a formal Brexit process, and the BOE kept rates on hold. The BOE also hiked its economic and inflation forecasts and reversed course on a planned additional rate cut, moving to a stance in which it may next move either up or down.
All this just after BOE chief Mark Carney, facing rebukes from critics in government who accuse him of being biased against Brexit, said he would leave the bank in 2019, declining an option to stick around until 2021.
Should I mention that UK inflation is now forecast by the BOE to nearly triple to 2.7% in the next year, a view largely driven by post-Brexit sterling losses which are now very much up in the air?
To call the situation a quagmire is to leave out the multiple-ferrets-in-a-sack aspect.
What those investors whose mandates force or allow them exposure to UK assets are expected to think of all these layers of complexity piled upon uncertainty I cannot say.
The Monetary Policy Committee, similarly in a tough spot, is not making things simpler, though one could argue they have no choice.
“The MPC has a very hard time admitting that it is wrong, and even more difficulty saying that it simply does not know what will happen next in light of all the Brexit and fiscal uncertainty,” Carl Weinberg of consultancy High Frequency Economics wrote in a note to clients.
“The MPC’s plan appears to be to plow ahead with QE and (keep) a stiff upper lip, at least until the December 15 meeting.”
The BOE, having eased in response to an expected hit to growth from Brexit, almost doubled its call on UK output growth for 2017 to 1.4%.
Weinberg points out that the projections in the November Inflation Report, released on Thursday, were based on an assumption that Prime Minister Theresa May’s spending plans, and tax and benefit rates, will be as set out in the March budget. This is absurd; the March budget was made by some now only dimly remembered politicians long ago before the world changed with the Brexit vote.
Credibility problem or simply unbelievable?
This cannot help the credibility of the BOE, even with the most charitable allowances made for the difficulties they don’t control.
The situation after the High Court ruling raises the level of uncertainty over Britain’s future, and obviously the outlook for its markets, to a simply unbelievable level. May had pledged to trigger Article 50 by March, asserting her government had the right under royal prerogative to begin a process almost certain to lead within two years to a formal EU exit. The Court says Parliament must vote.
Now the case moves to the UK Supreme Court, which may or may not uphold Thursday’s result, for a final ruling. Place on top of this possibility the odds of Parliament voting to trigger Article 50, and if so by when. Less certain still is if the pledge of a March delivery of a legal Article 50 notice to the EU can happen.
Many expect May could now choose to call a snap general election for early 2017 in hopes of securing enough MPs to be able to win a Parliamentary vote on Article 50. While May enjoys high approval ratings and a weak opposition, Brexit remains an extremely divisive and volatile issue.
Trying to work out the odds of all of the above, especially given further uncertainty over political developments elsewhere in the EU, is a very, very difficult task.
Within this context it may help to remember two allied but sometimes opposing forces: markets hate uncertainty and asset managers will manage their own career risk first.
The old saw that markets hate uncertainty is true enough but is governed itself by the laws of self-preservation as practiced by agents like fund managers hired to make decisions for asset owners. We should expect there to be a higher risk premium imposed on sterling assets given the potential volatility due to the range and complexity of outcomes. Some of this premium likely is already partly embedded in prices, of course.
Making a big bet based on predicting a complex outcome sounds like a career-making move for a fund manager, but the reality is that such an attempt is more likely to go wrong and get you fired.
Asset managers, though, may simply do very little, hugging their mandated index weightings like security blankets.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
