BoE pushes the boat out to support the economy

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The Bank of England ended a seven-year tradition today and changed the Bank rate, cutting it by 25 basis points to an historic low of 0.25%.

There was a lot of information from the BoE today so in this blog we’ll focus on the decision, its updated economic forecasts, and what we think it will mean for the economy.

Today was the BoE’s third Super Thursday for this year, involving the simultaneous release of the interest rates decision, minutes of the meeting, and updated forecasts. The rate cut was accompanied by an expansion of its quantitative easing program and the introduction of a Term Funding Scheme, which involves the BoE providing funding for banks at interest rates close to the Bank rate. The BoE’s asset purchases were increased by £70 billion to £435 billion, consisting of £60 billion of government bonds and £10 billion of corporate bonds. This marked the first time that the BoE has bought corporate bonds.

BoE25bpcut 

The aggressive policy action suggests that the information available to the BoE about the potential negative impact of the referendum result on the UK economy made it sufficiently concerned to act. While there’s still no concrete evidence about the impact of the vote on the real economy, the BoE’s updated economic forecasts appear to have been the trigger.

BoE downgrades its growth forecasts…

The BoE’s economic forecasts show it has revised down its outlook for UK economic growth. The economy is now seen as growing 1.8% this year and 0.8% in 2017, compared to 1.9% and 2.3% respectively in its previous forecast in May. The BoE’s growth forecasts are roughly in line with our central expectation for this year and next.

The downgrade in the BoE’s growth outlook was largely on the back of a sharp downward revision to business investment, which is now seen as contracting 3.75% this year and 2% in 2017. Previously, business investment was forecast to grow 2.5% and 7.25%, respectively.

GDPreviseddown 

…but revises up inflation forecasts

The recent weakness of Sterling against major currencies, which has put upward pressure on import prices, has led the BoE to revise up its inflation forecasts. Sterling depreciated to a 31-year low against the US dollar following the referendum result and subsequently only strengthened slightly.

The annual inflation rate at the end of this year is now expected to be 1.3% and 2% in late 2017, up from 0.9% and 1.8% previously. The forecasts of weaker GDP growth and higher inflation puts the BoE in a dilemma. The Bank’s mandate includes keeping inflation under control and supporting growth. If it tightened monetary policy to keep inflation in line with its 2% target, this would weigh on economic activity, and vice versa.

Inflationrevisedup 

A positive move for the economy

The BoE’s aggressive policy action is a positive move for the UK economy. The lower official interest rates, and purchases of government and corporate bonds, should put downward pressure on borrowing costs. Also, Sterling has weakened since the decision because while the 25 basis point cut was fully priced in by financial markets, the expansion of quantitative easing and introduction of the Term Funding Scheme weren’t. If the resulting fall in Sterling is sustained, it could potentially boost exports.

Similarly, the introduction of the Term Funding Scheme is a positive move for two reasons. First, it prevents the rate cut from squeezing the profit margins of banks, which potentially could have discouraged them from lending to the real economy. Second, it provides banks with a cheap source of funding to support additional lending. While it’s good to see measures to make it easier for businesses to access credit, the scheme’s success will depend on whether there is the demand for it.

 

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