
Bank of England Prepares to Cut Rates into Uncharted Territory, According to Reuters
By David Milliken
LONDON (Reuters) – The Bank of England is poised to implement its first interest rate cut since 2009 on Thursday, aiming to prevent the United Kingdom’s exit from the European Union from plunging the economy into recession.
In addition to lowering rates, the Bank may also inject billions of pounds into financial markets.
Recent economic surveys indicate a significant slowdown following the BoE’s unexpected decision to maintain interest rates two weeks ago, while deliberating an unspecified package of stimulus measures likely to be introduced in August.
Manufacturing data released on Monday indicated the most widespread decline since early 2013, while earlier surveys of the services sector revealed the steepest contraction since 2009.
There exists a possibility that these reports are a result of an immediate reaction to the Brexit vote, leading to a complex situation for the Bank as it considers how aggressively to respond.
Andy Haldane, the BoE’s chief economist, expressed a desire to adopt a strong approach, while fellow policymaker Kristin Forbes advised caution, suggesting the central bank should wait for more concrete data before making a decision.
Most economists surveyed expect the BoE to lower interest rates by at least 0.25 percentage points to 0.25 percent, with nearly half anticipating a restart of its quantitative easing bond purchase program, which has been dormant since late 2012.
"In times of potential crisis, it’s better to take action proactively rather than waiting until you’re facing a severe impact," stated Robert Wood, an economist at Bank of America Merrill Lynch and former BoE forecaster.
Wood noted that any monetary policy adjustments would need time to exert their effect. He predicts the BoE will announce an asset purchase program totaling £50 billion, on top of the £375 billion in government bonds acquired from 2009 to 2012.
Conversely, some believe the Monetary Policy Committee might be wary that further quantitative easing, in the context of already historic low global bond yields, could lead to unpredictable outcomes for financial institutions and markets.
"Recent survey data, taken at face value, suggests a significant recession may be imminent. However, since there could be elements of a temporary reaction, the MPC might consider waiting for more data before making any major decisions," remarked Simon Wells, an economist at HSBC.
Surveys conducted in early July could be influenced by political upheaval, particularly following the resignation of Prime Minister David Cameron and the search for a new Conservative Party leader. Some existing data, including the Bank’s own research, indicate a relatively modest response to the referendum outcome.
DIVIDED MPC
Bank of England Governor Mark Carney will unveil the policy decision during a news conference; however, consensus within the MPC may be lacking.
Forbes previously stated that while looser monetary policy has benefits, it also has costs, emphasizing the need for the BoE to await better data for an appropriate calibration of its response.
The efficacy of rate cuts and asset purchases is also uncertain, especially given that 10-year British government borrowing costs have already reached a low of 0.7 percent.
"At this point, monetary policy has very limited room to maneuver," Wood noted, suggesting that the government would likely need to implement increased spending or tax cuts to stimulate the economy.
Wells, also a former BoE staff member, indicated it might be premature for Carney to suggest the Bank would emulate the Bank of Japan by acquiring bonds to support fiscal stimulus, which the UK government has only hinted at thus far.
"The Bank may propose such strategies, but this creates significant policy risks for the future and could undermine the BoE’s operational independence," Wells cautioned.
A more likely strategy involves extending the Funding for Lending Scheme, which provides banks with inexpensive financing in exchange for increased lending to the private sector and was being gradually phased out as the economy showed signs of recovery.
The Bank may also explore other measures to ensure that lower interest rates do not diminish financial institutions’ willingness to lend.
Additionally, the BoE is set to release a quarterly update outlining its growth and inflation forecasts. The 12 percent drop in the value of the pound since the referendum is expected to lead to a revised projection indicating that inflation will surpass the 2 percent target next year due to increased import costs.
Growth forecasts are certain to be revised downward, with the key question being whether the central bank will anticipate a recession. Before the referendum, Carney noted that in the event of a vote to leave the EU, he expected a material slowdown rather than a recession as the central scenario.