Last Thursday at its August meeting, the Bank of England (BoE) delivered a comprehensive monetary policy response to the Brexit vote.
In addition to the expected 25 basis points cut of the base rate to 0.25%, the central bank announced a stimulus package containing a new Term Funding Scheme, a revival of the Asset Purchase Facility with a total of £60bn of guilts to be bought over the next six months and a new £10bn corporate bonds purchasing scheme.
In the August edition of the quarterly Inflation Report published alongside the meeting, the BoE sounded rather upbeat about its policy to support economic momentum, with a Q2 surprise keeping 2016 growth at an above-consensus 2.0%, and a Brexit-related decline to 0.8% in 2017.
The inflation forecast, revised up to 2.4% by 2018, shows that the BoE is willing to allow for inflation overshoots, while it clearly prioritises stimulating growth.
While the surprisingly large stimulus package in theory supports our below-consensus bearish outlook for the British pound, the currency has reacted rather unimpressed to the BoE’s ‘overdelivery’ in the days since the announcement.
It seems that markets are already focusing on the likelihood and potential for further stimuli. Indeed, we do not believe that the BoE’s policy response alone will be sufficient to limit the downside on growth, which is strongly related to the uncertainty surrounding the implementation of the Brexit vote.
We believe that clear political guidance and a reaction from the fiscal policy front would be necessary to prevent the UK from recording a technical recession in the second half of this year. Until the political aftermath of the Brexit vote is digested and the road paved for a fiscal response, the focus will remain on the BoE.
To be frank, there is room for further BoE action, if economic data turn out worse than expected in the coming weeks and months.
Although the BoE prefers not to lower rates into negative territory, other central banks have shown that rates can go below 0.25% in times of desperation.
On the asset purchase front, the BoE’s balance sheet may increase towards 30% of gross domestic product with the announced asset purchases measures, but remains rather moderate when compared to the European Central Bank’s (ECB) or the Bank of Japan’s (BoJ) programmes.
Whether more asset purchases will be effective, however, can be debated when considering the criticised corporate bond purchasing plan of the ECB, or the BoJ’s struggle with fading effectiveness of its ever-growing monetary policy measures.
David A. Meier is an economist at Julius Baer