Continuing the tradition of the last seven years, the BoE kept the Bank rate on hold at 0.5%. Similarly, the BoE’s asset purchase program remained at £375 billion. The main development was that the decision of the BoE’s monetary policy committee was no longer unanimous, as one of the nine members voted for a rate cut.
The decision to keep monetary policy on hold was a bit of a surprise to some economists because the BoE had been on the front-foot since the referendum, with proactive measures including offering £250 billion in additional liquidity to banks if required and relaxing countercyclical capital requirements on them. Also, Governor Mark Carney has said that some monetary policy easing would likely be required over the summer.
In addition, the decision signals that the BoE is waiting until next month when its quarterly Inflation Report – which will contain updated economic forecasts – is due before deciding what to do. The BoE acknowledged that it’s too early to tell about the impact of the referendum but acknowledged some businesses were beginning to postpone recruitment and investment plans. This chimes with what we’ve heard from some of our members.
An August rate cut is on the cards
In light of today’s decision, the BoE is likely to cut the Bank rate and/or expand its asset purchases in August. Such a move is likely, on balance, to be a positive for UK manufacturers. A lower Bank rate typically stimulates economic activity but there’s some debate as to whether this would still the case because it is already very low. Also, a cut in the Bank rate could put additional downward pressure on Sterling, improving the price competitiveness of UK exports on international markets and thereby potentially boosting demand. However, Sterling has already depreciated significantly against major currencies following the referendum result and it’s difficult to know whether investors have already fully factored in the upcoming cut in the Bank rate.
BoE has limited room to move
The room for the BoE to loosen monetary policy by using conventional measures is limited. On the interest rate front, there’s only scope for a 50 basis point cut to 0%. Nevertheless, the BoE could expand its quantitative easing program by increasing its asset purchases beyond £375 billion. This would be likely to push down bond yields, which akin to a lower Bank rate typically stimulates economic activity. A more radical option would be for the BoE to lower interest rates into negative territory. The BoE’s counterpart in Sweden has already done so but there are strong arguments against such a move because it would penalise savers.
The BoE’s lack of room to move puts the onus on the new government led by Prime Minister Theresa May to take additional measures to support the UK economy. Recent proposals made while George Osborne was Chancellor such as dropping the fiscal deficit reduction program and planning to cut the corporation tax rate to below 15% were in the right direction. The bottom line is that additional policy measures need to form part of clear industrial strategy for the UK, which prioritises delivering a more competitive business environment for manufacturers.
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