Bank of England wields many tools in search for stability
After today’s Bank of England announcement, David Stubbs and Nandini Ramakrishnan review the details and discuss the potential impacts.
What has the Bank of England (BoE) done today?
The package of measures announced by the BoE today featured five key policy elements: it halved the Bank Rate from 0.5% to 0.25%, provided guidance that rates would fall further and restarted its Gilt-buying programme, to the tune of GBP 60 billion. The BoE also introduced two measures designed to support lending to UK companies: it added a new Term Funding Scheme to reinforce the pass-through of the cut in the Bank Rate, and committed to purchasing up to GBP 10 billion of UK corporate bonds.
Today’s action by the BoE represents a significant step towards supporting growth and employment in the UK in the aftermath of the referendum. The BoE also continues to use regulatory changes to support the financial system itself. It has amended the UK leverage ratio, by excluding bank reserves. This comes in addition to cutting the counter-cyclical capital buffer set by the Financial Policy Committee from 0.5% to 0% on 5 July. Both measures are aimed at reducing the regulatory requirements on banks.
What will be the impact of today’s announcements, and what is the outlook for policy?
The lower policy rate, and the guidance that it could fall further, should lower mortgage payments in coming months for households. Half of these mortgages are floating rate, and for companies, four out of five bank loans are on variable terms. By buying more Gilts, the BoE hopes to reduce the lending rates for longer term loans as well.
Perhaps the most interesting part of this policy package is the new Term Funding Scheme (TFS), which replaces the old Funding for Lending Scheme. The TFS will provide up to GBP 100 billion for banks at interest rates close to Bank Rate, making it easier for them to lend money. This should help the effects of the cut in Bank Rate to filter through to the real economy, and ensure that households and firms benefit from low interest rates. To complement the TFS, the Bank’s corporate bond purchases will improve financing conditions and support investment.
All measures can be expanded and added to, and the MPC (Monetary Policy Committee) predicted that rates would fall to zero later this year. It is not surprising as they lowered growth in 2017 from 2.3% to 0.8% and in 2018 from 2.3% to 1.8%, and also forecast that unemployment will rise to 5.5%, a net loss of around 250,000 jobs. However, BoE Governor Mark Carney went further than ever before in ruling out negative interest rates, by stating that the committee sees the effective floor for the Bank Rate as being “a positive one, close to zero”. One determinant of the scale of future monetary policy is the degree of support from fiscal policy. Carney stated that he had discussed the situation with the new Chancellor, Phillip Hammond, and we expect that the government is now preparing a significant package of measures to help support the economy. These measures are likely to be announced in November’s Autumn statement, but could potentially come sooner if economic data deteriorates in the meantime.
It is clear that the MPC is concerned about the scale of the economic slowdown. There is still more it can do in coming months, with further room to cut interest rates and plenty of scope to increase asset purchases beyond today’s commitment. Despite the fact that investors are already heavily positioned for further falls in sterling, we expect the weakness in GBP/USD to be continued throughout the year, on top of today’s 1.6% fall. Gilt yields also fell and the yield curve flattened. We do not expect a significant reversal in either of these moves any time soon. Equity markets reacted well, with both the FTSE 100 and FTSE 250 rising around 1.5% after the announcement. Most sectors benefited, although the homebuilders and real estate companies modestly outperformed.
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