One of the many significant moments on Friday in the hours after it emerged Britons had voted to leave the European Union was the statement from the Bank of England governor, Mark Carney.
“As a backstop, and to support the functioning of markets, the Bank of England stands ready to provide more than £250 billion of additional funds,” Carney said, in an extremely rare live TV appearance from a central bank governor. “The Bank of England is also able to provide substantial liquidity in foreign currency, if required. We expect institutions to draw on this funding if and when appropriate, just as we expect them to draw on their own resources as needed in order to provide credit, to support markets and to supply other financial services to the real economy. In the coming weeks, the Bank will assess economic conditions and will consider any additional policy responses.”
Two hundred and fifty billion pounds. It’s around $US350 billion, nudging half a trillion Australian dollars. It is a staggering financial backstop, but that is price of stopping financial Armageddon in the ever-more-interconnected global financial system.
Some in the markets don’t think this will be enough, including Bank of America Merrill Lynch, which has issued a note to clients bearishly-titled: “Hello recession”.
“We expect a recession,” is one of the straightforward statements in the note, which explains that the forthcoming period of heightened uncertainty will crush economic momentum in the UK, with a 2.5% drag on GDP growth over the next 12 months and a “mild recession lasting three quarters”.
BAML sees the Bank of England firing some big policy cannons in the months ahead. Robert Wood and Gilles Moec write (emphasis added):
We expect the Bank of England (BoE) 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 at their July 14 policy meeting. We also expect the BoE to relaunch Quantitative Easing (QE) with a £50bn salvo. We pencil that in for August. But the timing is more uncertain than on interest rates, given that starting QE would probably be interpreted as a signal of a lot more to come which could be risky given the current account issues (see below). Indeed, we think further easing would probably follow any initial salvo, provided those tail risks do not manifest.
Given the experience of negative interest rates elsewhere we expect the BoE to cut below zero only as a last resort. But the easing may not be too effective. Cutting rates below 50bp may have costs as well as benefits, like impairing the transmission mechanism of monetary policy. Meanwhile QE might not be as potent as it was after
the financial crisis. This alone is a good reason to see large downside risks to growth.
In our view, it will also be difficult for fiscal policy to bring much support to the economy. We do not believe the UK government will embark on the all-out austerity drive sketched out by Chancellor Osborne last week, but the Brexit debate has focused investors’ mind on the UK’s twin deficit. Fiscal policy has room to support the economy,
given that the UK borrows in its own currency and does not have extreme levels of public debt. But policy is certainly more constrained than before the financial crisis.
Especially with the potential prospect of key sources of income in the budget being eroded (eg. the City of London) and the potential for a damaging current account crisis if the UK-EU negotiations go badly. So we do not expect a large fiscal stimulus.
So, 50 bips in rate easing, £50 billion in QE, and the effect may be limited.
Over to you, Mark Carney.