The Bank of England has cut interest rates for the first time since 2009. The rates, lowered to 0.25% from 0.5%, are now the lowest they have been in UK history.
The rate cut was widely expected after the June 23 vote for a British exit from the European Union, or Brexit. Several recent forecasts, including those from Credit Suisse and Barclays, suggest that Britain is plunging toward recession. The pound fell almost 1% immediately after the rate cut.
The basic argument for the rate cut is to stimulate economic growth by encouraging people to borrow and invest. This, in turn, should help to spur inflation.
Britain’s central bank also unleashed a substantial new monetary-easing programme, including the extension of its asset-purchase facility to £435 billion from £375 billion and, in a move with little precedent in Britain, included UK corporate bonds in its monetary-easing programmes.
As much as £60 billion of new government debt will be purchased and up to £10 billion of corporate bonds can also be purchased. The bond buying will begin in September, the bank says.
At the bank’s second Monetary Policy Committee meeting since Britain voted to leave the European Union, Governor Mark Carney and the other members of the committee decided that taking Britain’s interest rate closer to zero and extending quantitative easing was the best means of mitigating risks to the economy after the Brexit decision.
Along with the rate cut and the new easing programme, the BOE also announced a new so-called Term Funding Scheme, to give the UK’s banks access to a new line of funding. At its most basic level, the TFS is designed to make sure that the assumed positive impacts of the rate cut make it into the real economy, and in the words of the bank “ensure that households benefit from the MPC’s actions.”
Here’s more from the bank on what the TFS means:
“The cut in the Bank Rate will lower borrowing costs for households and businesses. However, as interest rates are close to zero, it is likely to be difficult for some banks and building societies to reduce deposit rates much further, which in turn might limit their ability to cut their lending rates.
“In order to mitigate this, the MPC is launching a Term Funding Scheme (TFS) that will provide funding for banks at interest rates close to Bank Rate. This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions.
“In addition, the TFS provides participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.”
The nine members of the committee voted unanimously in favour of a rate cut and the introduction of the TFS. Three members of the committee — Kristin Forbes, Martin Weale, and Ian McCafferty — voted against extending the BOE’s government bond-buying scheme.
Forbes, who has advocated a “Keep Calm and Carry On” approach since the Brexit vote, also voted against implementing a programme of corporate bond buying. She was the only dissenter in this regard.
The minutes of the MPC’s meeting cited a desire to protect the British economy from the initial shock of the Brexit vote as the reason for the huge stimulus package, noting:
“Following the United Kingdom’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short-to-medium term has weakened markedly. The fall in sterling is likely to push up on CPI inflation in the near term, hastening its return to the 2% target and probably causing it to rise above target in the latter part of the MPC’s forecast period, before the exchange rate effect dissipates thereafter. In the real economy, although the weaker medium-term outlook for activity largely reflects a downward revision to the economy’s supply capacity, near-term weakness in demand is likely to open up a margin of spare capacity, including an eventual rise in unemployment. Consistent with this, recent surveys of business activity, confidence and optimism suggest that the United Kingdom is likely to see little growth in GDP in the second half of this year.”
Rate cut meets expectations
The rate cut was widely expected, with markets pricing a near 100% chance that a cut would come Thursday. A survey of more than 50 economists by Bloomberg showed just two expected the bank to leave rates unchanged. Leaving interest rates unchanged for a record 89th consecutive month would have been a huge shock for markets.
The extension of bond buying, while not massively shocking, was not as widely expected. The introduction of corporate bond buying will be of particular interest to the markets since it has only briefly been experimented with in the past — when the bank purchased small amounts of corporate bonds at the beginning of its previous QE scheme.
Corporate bonds will be eligible for the bank to purchase only if they are of investment grade and in companies that have substantial UK operations and make a material impact on the British economy. Companies do not necessarily have to be headquartered in the UK to be eligible.
Britain’s interest rates had stayed at a historic low of 0.5% since March 2009. Before Britain voted to leave the European Union on June 23, the BOE was priming itself to eventually start raising rates again. But given the economic shock of the Brexit vote — which sent the pound crashing and brought about widespread predictions of recession — the bank decided that a new programme of monetary stimulus was the best course of action.
The move is such a departure from the bank’s recent policy that before August’s meeting only one member currently serving on the MPC — Gertjan Vlieghe — had ever voted for a rate cut. That vote came at July’s MPC meeting, when the bank unexpectedly left rates on hold.
Growth forecasts downgraded
Alongside the bank’s new monetary policy measures, it revealed in its quarterly Inflation Report that it was downgrading the UK’s growth forecast for 2017 to just 0.8%, from 2.3% at the previous Inflation Report, representing the biggest quarter-to-quarter downgrade in the bank’s one-year forecast since it started producing the Inflation Report in 1992.
By 2018, growth should return to 1.8%, down from 2.3% at the previous estimate. The new forecasts take into account a material positive impact on the British economy from the bank’s new stimulus measures. For the rest of 2016, growth will begin to slow sharply, the bank said, with growth in Q3 of the year set to fall to just 0.1%. It did not release forecasts for Q4 of 2016 or Q1 of 2017 but said the UK was not expected to slip into technical recession during that time.
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