Bank of England Cuts Rates, Prepared for ‘Whatever Action Necessary’ After Brexit Vote, Says Reuters

By David Milliken and Ana Nicolaci da Costa

LONDON – On Thursday, the Bank of England implemented its first interest rate cut since 2009, reinstated its bond-buying program, and declared it would take “whatever action is necessary” to ensure stability following Britain’s decision to exit the European Union.

The central bank projected that the economy would stagnate for the remainder of 2016 and face sluggish growth in the following year. It reduced its main lending rate to a historical low of 0.25 percent from 0.5 percent, aligning with market forecasts.

Additionally, the bank introduced two new initiatives: one for purchasing 10 billion pounds of high-grade corporate bonds, and another, potentially valued at up to 100 billion pounds, aimed at ensuring banks continue to lend despite the reduced interest rates.

In reaction to the announcement, the value of the pound fell by 1 percent against the dollar, British government bond yields reached all-time lows, and the main share index increased by 1 percent.

Most members of the Monetary Policy Committee (MPC) also anticipated another cut to the Bank Rate later this year, potentially bringing it “close to, but a little above zero,” if the economic downturn was as severe as projected.

In its quarterly Inflation Report, the Bank noted that following the Brexit vote, the exchange rate had declined significantly, and the short- to medium-term growth outlook had deteriorated sharply.

Governor Mark Carney stated that actions had been taken due to significant changes in the economic outlook following the referendum.

“By acting early and comprehensively, the MPC can reduce uncertainty, bolster confidence, mitigate the slowdown, and support the necessary adjustments in the UK economy,” he explained at a news conference.

Carney emphasized the Bank’s readiness to take necessary actions to achieve its monetary and financial stability objectives as the UK adapts to new realities and strives to seize opportunities outside the EU.

Finance Minister Philip Hammond expressed support for the interest rate cut, asserting that he and Carney have “the tools we need to support the economy as we embark on this new chapter and address forthcoming challenges.”

Policymakers displayed some division regarding the response to Brexit’s effects. While the rate cut and the Term Funding Scheme (TFS) aimed at ensuring banks passed on the rate benefit to consumers received unanimous backing, three members—Kristin Forbes, Ian McCafferty, and Martin Weale—opposed raising the target for quantitative easing government bond purchases.

Forbes also contested the corporate debt purchases, which the Bank had previously implemented to promote market functioning post-financial crisis rather than stimulate growth.

Many economists had anticipated Forbes’s opposition to the rate cut after she indicated that the central bank should wait for more data regarding the extent of the economic slowdown.

Daniel Mahoney from the Centre for Policy Studies highlighted the possible inflationary consequences of the Bank’s easing measures.

“The Bank’s further loosening of monetary policy could pose challenges for the UK economy. The declining pound is already leading to inflationary pressures, and today’s decision will exacerbate them,” he stated.

SLOWDOWN AHEAD

While numerous business surveys indicate a sharp slowdown in the UK economy, with the possibility of recession looming, official data on the impact of the EU vote on output is not yet available.

The Bank maintained its 2016 growth forecast at 2.0 percent, as the economy performed better in the first half of the year than anticipated. However, the growth outlook for 2017 was significantly downgraded to just 0.8 percent from a prior estimate of 2.3 percent—the largest adjustment between inflation reports, surpassing changes observed during the financial crisis. The forecast for 2018 was likewise reduced to 1.8 percent.

The Bank also sharply revised its inflation predictions upwards due to the considerable decline of the pound, expecting it to reach 2.4 percent in 2018 and 2019. The MPC noted that the costs of attempting to rein it back to the 2 percent target in the near term would outweigh the benefits.

The Term Funding Scheme was launched to ensure that the new lower interest rates set by the Bank are reflected in borrowing costs for households and businesses.

The Bank indicated it does not expect the scheme to significantly accelerate overall loan growth, but instead to mitigate any reduction in lending resulting from the interest rate cut.

Eligible institutions will have the ability to borrow central bank reserves for four years for an initial period of 18 months at rates close to the Bank Rate.

Banks that maintain or increase net lending to the economy will benefit from the lowest funding costs of 0.25 percent, while a penalty rate will apply for those that reduce lending.

The MPC affirmed that it could modify the terms and duration of the scheme, funded by central bank reserves, with lending values determined by usage and potentially reaching around 100 billion pounds.

Hammond, who succeeded George Osborne a month ago, authorized the bond purchases and the TFS.

“Alongside the actions the Bank is taking, I am prepared to take any necessary steps to support the economy and promote confidence,” Hammond conveyed in a letter to the central bank.