Britain cuts rates to mitigate the impact of June’s Brexit vote

As expected, the Bank of England announced a 25 basis points cut in its bank rate to 0.25% from 0.50% following last week’s meeting of its Monetary Policy Committee (MPC).

The decision was unanimous, with all nine Committee members voting for the rate cut. 

It was the first change to the bank rate since March 2009, when it was reduced from 1.00% to 0.50%.

Furthermore, the BoE provided something of a surprise by also announcing it would purchase an additional £60bn of UK government gilts (ie fresh QE) over the next six months.

This will bring its total gilt purchases to £435bn. The decision to expand gilt purchases was not unanimous, though, with three MPC members voting against it.

The BoE is also to purchase up to £10bn in UK corporate bonds. In addition, it is launching a new term funding scheme to provide funding for banks at interest rates close to bank rate.

Overall, the extensive package of easing measures went further than had been anticipated by many market watchers.

The BoE emphasised the policy easing measures were being adopted in order to help mitigate the weaker medium-term outlook for economic activity following the UK’s vote to leave the EU.

This is despite the fact the bank now foresees a temporary period of above-target inflation as a result of the weakening of sterling.

As such, the BoE acknowledged policy easing represented a trade-off between delivering inflation at the target rate of 2% and stabilising economic activity. 

The BoE also indicated it was prepared to ease policy again. 

The meeting minutes stated if incoming data prove broadly consistent with its latest forecasts, then a majority of members of the MPC expect to support a further cut in bank rate to “its effective lower bound” before the end of the year.

In his press conference, BoE governor Carney highlighted that the MPC see the effective lower bound for interest rates as a positive number.

He made it clear that he is not a fan of negative interest rates.

Thus, while another UK rate cut is a distinct possibility, it looks unlikely to be a full 25 basis points reduction. 

Instead, the bank rate is more likely to be cut from 0.25% to 0.1%, or possibly 0.05%.

Meanwhile, the latest set of BoE forecasts showed a marked downgrading of the outlook for activity.

The economy is now expected to show little growth in the second half of 2016. 

The bank noted recent surveys point to a pronounced slowdown in growth from the 2% rate evident in the first half of the year.

In this regard, the Markit composite PMI fell below the expansion indicating 50 level in July, hitting an over seven-year low of 47.5. 

Meanwhile, the EC measure of UK economic sentiment fell to 102.6, an over three-year low.

Measures of consumer sentiment have also recorded large declines. The EC measure fell to -9.2 in July, from -1.2 in June. This represents its largest month-on- month fall since January 1991.

Likewise, the Gfk measure of consumer confidence fell from -1 to -12 in July, its sharpest fall since March 1990. The falls in all these indices, if sustained, would point to a likely contraction in GDP in the third quarter.

Overall, the UK economy is facing into a period of heightened uncertainty. This is likely to weigh on consumer spending and business investment.

Hence, the previous BoE 2.3% GDP growth forecasts for both 2017 and 2018 have been cut to 0.8% and 1.8%, respectively.

Indeed, the 2018 forecast may well prove overly optimistic.

Meanwhile, the BoE inflation forecasts were revised slightly upwards, reaching 2.4% by the end of 2018, compared to 2.2% previously.

Overall, last week showed the BoE is very concerned about the outlook for the UK economy, with further monetary easing in the near-term a distinct possibility.

The immediate market reaction saw sterling weaken, with GBP/USD falling from $1.33 down towards $1.31, while EUR/GBP moved from 83.5p up near to the 85p mark. 

Further sterling declines could well be in store in the coming months if the UK economy weakens in line with the BoE’s downbeat outlook.

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