The Bank of England cut interest rates to 0.25 percent Thursday for the first time in seven and a half years from its previous record low of 0.5 percent. While the cut was fully expected, they made a more aggressive move by adding a £170 billion package of quantitative easing, including buying government and corporate bonds, and a lending program for banks that will ensure that the additional liquidity will reach the economy.
The market welcomed the actions and has responded positively. The British pound sterling fell by close to 2 percent, UK gilts have rallied and their stock market rose. Even the credit rating agency Moody’s welcomed the Bank of England’s move, saying it is “mildly credit positive” for sterling borrowers.
In his press conference, BOE Governor Mark Carney made some interesting remarks:
- The stimulus has been targeted at the UK domestic economy and not the exchange rate.
- The slide in GBP will push up consumer prices notably over the next three years.
- Lower rates will be felt immediately in the economy and the monetary policy committee is determined that the stimulus does not get diluted as it passes through the financial system.
- He is not a fan of negative interest rates, as they may penalize savers.
The BOE did not act last month immediately after the Brexit referendum but waited for further economic evidence. The decision was unanimous this week, when even the most hawkish member acknowledged weaker-than-expected business confidence.
They were sensible to wait and then act aggressively to reduce further uncertainty.
Meanwhile the Chancellor of the Exchequer, Philip Hammond, also responded favorably, noting that the Governor and the Chancellor have the tools available to support the economy. Given that Brexit is a one-time supply side shock based on a regime change, an aggressive combination of both monetary and fiscal policies are clearly justifiable and the market is now waiting for some aggressive fiscal response this autumn.
My View: The key to the success of this week’s BOE decision was the additional focus to ensure that cash will not be hoarded by financial institutions, corporations and consumers. If this program is successful, the GBP will probably remain under pressure, which should eventually drive up inflation to the level above 2 percent targeted by the monetary policy committee.
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