By William Schomberg
LONDON (Reuters) - The Bank of England has acknowledged the glaring mismatch between its base-case scenario that Brexit will go smoothly and growing bets by investors that Britain's departure from the European Union is likely to be messy.
The BoE on Thursday noted "the ongoing tension" between its premise that Britain would ease its way out of the EU with a transition deal and "the assumptions about alternative Brexit scenarios that were priced into the financial market variables".
The statement reflects how BoE Governor Mark Carney and his fellow interest rate-setters are struggling to convince investors that borrowing costs are likely to rise any time soon, due to the deep uncertainty about how Brexit will play out.
The BoE, reflecting the stated aim of Prime Minister Theresa May's government to reach a transition deal, has not included the possibility of an abrupt shift to World Trade Organization rules for trade with the EU in its central case assumptions.
As they kept rates on hold on Thursday, the BoE's rate-setters said once again that "an ongoing tightening of monetary policy over the forecast period, at a gradual pace and to a limited extent" would be needed, if a no-deal Brexit is avoided.
But a no-deal Brexit is looming larger for investors.
The contenders to replace May say they are prepared to leave the EU without a transition arrangement to smooth the shock, possibly as soon as the latest Brexit deadline of Oct. 31.
Many economists expect no rate hike for more than a year. Some investors are pricing in a chance of a cut: the money market curve now implies a roughly 25% chance of a 25 basis-point rate cut by the end of 2019, analysts at RBC Capital Markets said.
That compared with a 10% chance before Thursday's BoE announcement, which, as well as Brexit, highlighted risks from the growing global trade tensions which have prompted other central banks to turn dovish.
The assumptions mismatch between the BoE and the markets will narrow once the uncertainty about Brexit is cleared up, one way or the other.
But that is unlikely before Carney and his colleagues publish new forecasts for Britain's economy in early August.
And if May's successor extends the Brexit deadline once again, the next change in British interest rates will fall to a future governor of the BoE because Carney is due to stand down at the end of January.
(Writing by William Schomberg; Editing by Andrew Heavens)
