Emma Wall: Hello, and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Mike Bell, Global Market Strategist for JPMorgan.
Hi, Mike.
Mike Bell: Hi.
Wall: And it's a rollercoaster ride in the approach to Brexit. The latest polls are showing that actually the leave campaign has a seven-point win and this is also being reflected in the currency, isn't it?
Bell: It is. I think the currency hasn't priced in fully the impact that that a leave vote would have. In fact, I think if the polls actually prove to be correct and we do see a leave, you could see sterling fall by as much as another 10% from where we are here. So, I still don't think that the market is giving full credence to this latest poll, partly as a result of the fact that it was taken over a bank holiday which perhaps skews the actual result.
Wall: And just to look into those currency prices, this is the forward rate of which people fix currency. Perhaps you could explain a little bit more about that.
Bell: Yeah. Well, I mean, what you're seeing is that the volatility in the, sort of, sterling market is picking up at the moment. But really, you've seen in the spot rate as well to come off a couple of cents against the dollar recently. I think that what is going to be important from here is that the betting odds are still pricing a relatively high probability that we remain even though that you've seen this latest poll.
I think the polls are sort of going to bounce around a little bit and that could cause continued volatility in sterling. But, as I said, I think that you still have potential downside in sterling if we leave and a little bit further upside in sterling were we to say. I think that the downside in the leave vote scenario is much larger than the potential upside in the event that we actually remain.
Wall: And the 10% drop is significant and would, of course, have an impact on inflation, wouldn't it?
Bell: Yeah. I mean, very significant in currency terms. Those sort of moves are pretty unusual and I think the impact on the inflation outlook would also be significant and you'd see significant impact with the inflation picking up. That would put pressure on the Bank of England given that they would sort of be caught between an environment where the growth outlook would be weaker and yet the inflation outlook would be higher, making it difficult for them to know whether to put interest rates up or indeed to cut them.
Wall: Because one of the levers that they do use to tackle inflation and indeed, one of the reasons why we've had such low interest rates for the last seven years is because inflation has been so low. But if inflation picks up as a result of currency weakness, then they would normally, as you say, raise rates. However, if we do get a Brexit, you don't think that's going to happen?
Bell: Well, I actually think that there's sort of negative impact on growth as a result of the sort of slowdown in investment intentions that you would expect were we to leave. Also, the hit to trade given that there would be some uncertainty around whether we could actually do a deal on trading and services. I think that that sort of negative impact on the growth outlook, which we think would take U.K. growth down to somewhere around 0.5% to 1% growth as opposed to the closer to 2% growth that we forecast in the event that we stay in, I think that weaker growth would offset the sort of one-off temporary upwards pressure on inflation and therefore, if anything, the outlook for interest rates would probably be for a slight cut or maybe just staying the same. But I think that the sort of weaker growth outlook would offset that one-off inflationary rise.
Wall: And let's say that there isn't a Brexit; let's say that this latest poll is wrong, what then happens to interest rates do you think?
Bell: Well, I think that if the U.K. votes to remain then actually you're in a position where U.K. growth will rebound from the level that we're at, at the moment. You should see growth coming in at somewhere about 2% by the end of this year and probably next year as well. And in that environment with the labor market relatively tight, we would expect interest rates to start going up probably around the sort of first half of next year and then a sort of gradual path upwards from there.
Wall: And of course, the market will rebound because of sentiment, but why will growth rebound? I mean, why has even just the threat of Brexit meant sort of reduced growth for the U.K.?
Bell: Yeah. Well, at the moment, it's predominantly coming through because of investment intentions having weakened. If you look at the Bank of England's agent scores where they go out and ask companies what they are intending to do, what you saw is, until a couple of months ago, the service sector was holding up, its investment intentions were still strong. But in the last couple of months those have started to fall quite worryingly. The manufacturing sector had already been weak. But this sort of decline in the service sector is what's really hitting U.K. growth at the moment.
We think that were the uncertainty to be removed and that we just carry on as we have been within the EU that that would lead to a bounce in those investment intentions; people would continue to hire because at the moment I think that's one of the other things that companies have actually held back from hiring because of the uncertainty not knowing whether they would want to be adding jobs in Europe or adding them in the U.K. So, I think the combination of those two factors should lead to a rebound in U.K. growth in the sort of months after the referendum if we vote to stay.
Wall: Mike, thank you very much.
Bell: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
