Bank of England seen cutting rates first time in 7 years on Brexit Backlash
For the first time in more than seven years, analysts are finally expecting some action on U.K. interest rates from the Bank of England (BOE) when it meets for its first post-Brexit policy decision on Thursday.
In a bid to calm financial markets and shore up confidence after the U.K.’s unexpected vote to leave the European Union, the central bank is widely seen as reducing its key interest rate to 0.25% from a current record low of 0.5%, where it has stood since March 2009.
“The case for action is strong, not least with growing evidence of a sharp slowdown in the U.K. economy, including the early indications from surveys released last week that business and consumer confidence has plummeted in the aftermath of the vote,” analysts at Daiwa Capital Markets said in a note.
“Indeed, in our opinion, recession looks inevitable.”
The economic impact of a Brexit was hotly debated ahead of the June 23 referendum, with the “remain” side accused of scaremongering with “project fear”, while the “leave” camp was criticized for not dealing with realities. The BOE, meanwhile, was trying to strike a careful balance of addressing the potential economic impact of a Brexit, without seen as siding with either political stance.
Since the vote to ditch the union, however, BOE Governor Mark Carney & Co. has clearly expressed concerns over the outlook for the U.K. economy. In a speech on June 30, the central bank boss said the economic outlook has “deteriorated”, that increased uncertainty could cause unemployment to rise and that there are risks of “adverse spillovers to the global economy.” He also strongly hinted of imminent easing, saying “some monetary policy easing will likely be required over the summer.”
“The question then has become not if the MPC will ease but ‘what, how much and when,’” said Philip Shaw, chief economist at Investec, in a note.
“Carney alluded to a range of available policy options, some of which were not used previously. We are at pains to identify exactly what the Governor might have in mind here. Dropping cash from helicopters (or a practical equivalent), has been ruled out by several central banks and we do not see this as a realistic possibility,” he added.
Another option is restarting the bank’s quantitative easing program which has been in hibernation since July 2012, when it was increased by £50 billion ($64.94 billion) to a total of £375 billion. Some analysts see the BOE waiting until the policy meeting in August that coincides with the Quarterly Inflation Report to launch more asset purchases, while others expect more QE right away.
“If the Committee chooses to loosen in July, it may decide upon a ‘shock and awe’ strategy of both lower rates and more asset purchases,” Martin Beck, lead U.K. economist at Oxford Economics, said in a note.
The BOE’s Financial Stability Committee has already acted in the Brexit aftermath. Last week, it cut its countercyclical buffer for banks to 0% from 0.5%, in an effort to boost the economy. The move should free up £150 billion in extra capital for banks to lend out to businesses and households, the bank said.
The unexpected referendum result sent has sent shock waves through financial markets, with the pound tanking more than 10% against the dollar and euro Gilt yields dropping to record lows and the domestically-focused FTSE 250 index slumping almost 7%.
The benchmark FTSE 100 index however, has outperformed both its U.K. little sister and other European benchmarks as heavily-weighted exporters in the index, such as miners and tobacco companies, benefit from the exchange rate.
Analysts say the pound’s slide — for example hitting a 31-year low against the dollar — partially is because traders are pricing in a rate hike or two over the summer. Former Pimco executive and current chief economic adviser at Allianz Mohamed El-Erian has warned sterling could even hit parity with the dollar.
The BOE rate decision and minutes are out Thursday at noon London time, or 7 a.m. Eastern time.
Source: MarketWatch
