BoE to cut rates to avert expected Brexit slowdown

“The economic outlook has deteriorated and some monetary policy easing will probably be required over the summer,” said Mark Carney, the Bank of England governor, at the end of June.

Financial markets have already priced in a 75 per cent chance of interest rates being cut from 0.5 per cent to 0.25 per cent this week — the first rate cut in more than seven years. Rates are not expected to return to their current level for five years.

“We think the [Monetary Policy] Committee will recognise the dangers of disappointing market expectations and cut the Bank rate by 0.25 per cent,” said Jonathan Loynes of Capital Economics.

The recent depreciation of sterling is expected to push consumer price inflation up towards the BoE’s 2 per cent target. If the pound weakened further to parity with the dollar, inflation could rise “as high as 2¼ per cent by next May”, said Neil Williams of Hermes Investment Management.

But the Monetary Policy Committee is widely expected to look through any sharp short-term increase in inflation and instead aim to stabilise output and employment by loosening monetary policy.

Mr Carney seems keen to take quick, decisive action. But by the time of their meeting on Wednesday, the MPC will have only limited information about what effect the vote to leave the EU is having on the UK economy.

Hard economic data — such as figures for retail sales, employment and industrial production — will not be available until September and even survey evidence on business plans will not be published until August. For now, the MPC must rely on reports it receives from the Bank’s agents around the country, combined with other, less reliable, public information that has started to emerge.

During the financial crisis in 2008, reports from the Bank’s regional agents were one of the earliest signs that the economy was entering recession. The MPC meeting minutes on Thursday may provide an indication of what messages the Bank is receiving.

The governor has earned praise for a swift and decisive response to the Brexit vote. Danny Blanchflower, a former member of the MPC, said he was “impressed” by Mr Carney’s performance.

But others have suggested it would be unwise to react too soon. Writing in the Financial Times, Andrew Sentance, another former member of the MPC, said “we should keep monetary policy settings on hold until we have data on how the referendum result has affected the UK economy”.

Without a clear idea of how the vote has affected the economy, there is a risk that the BoE’s limited firepower is used up before it is known what is required. Even worse, responding too rapidly could be counterproductive if it led businesses and consumers to conclude the situation is worse than it is.

In 2009, the MPC concluded that cutting interest rates below 0.5 per cent would not have any beneficial effect and might actually be counter-productive because it would squeeze banks’ and building societies’ profit margins, making it more difficult for them to recapitalise or extend new loans.

But circumstances have changed since then. “The obstacles we saw to reducing the Bank Rate below ½ per cent are no longer material,” said Martin Weale, an external member of the MPC earlier this year.

source: Financial times