Brexit uncertainty to keep MPC in state of inertia

Brexit uncertainty has driven sterling lower in recent months and is likely to mean that the Monetary Policy Committee (MPC) keeps interest rates on hold for some time. But provided a Brexit deal is agreed, we still think that rates will rise at a faster pace than markets expect over the next two years, pushing up the 10-year gilt yield to 2% and paving the way for a rebound in sterling to $1.45/£ and around €1.20/£ by the end of 2019. That said, limited progress in the Brexit negotiations and divisions in the Conservative Party have raised the chances of the UK leaving the EU without a deal in March 2019. In this scenario, we would expect any further tightening of monetary policy to be put on hold, and interest rates could even be cut. The pound would fall further, perhaps to $1.20/£ and gilts would rally amid a “flight to safety”.