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Bank of England goes further than markets expected - HL comment

As well as unanimously voting to cut base rate to 0.25%, Bank of England will extend its Asset Purchase Programme (QE) by £60bn to £435bn, and for the first time it will also purchase up to £10bn of corporate bonds. A new Term Funding Scheme will provide funding for banks to support additional lending. This is designed to ensure the reduction in base rate feeds through to the rates faced by households and businesses.

Ben Brettell, Senior Economist, Hargreaves Lansdown:

Recent survey data has been so bad that anything other than a rate cut today would have disappointed markets. Expectations had also grown that a package of measures would be announced in addition to a 25bps cut in base rate.

In the event the Bank went further than markets anticipated, and as a result sterling immediately fell by more than a cent and a half against both the dollar and the euro. The FTSE 100 jumped almost 100 points, or 1.5%.

Whether these measures are appropriate, only time will tell.

Survey data shows referendum has caused significant uncertainty, and it seems certain some kind of negative shock is on the way. This is reflected in the downgrade in the Bank’s forecast for growth next year to 0.8%, down from 2.3% in its May forecasts. However, sentiment is more volatile than activity, so it’s possible the magnitude of the shock will be smaller than the survey data implies.

Even if you accept the economy is going to get sick, I would question whether lower interest rates and more QE are the right medicine.

The Term Funding Scheme will mean that banks aren’t reliant on savers’ cash, so I expect savings rates will be slashed. Yet savers have already accepted their cash is generating next to nothing – a cut in interest won’t mean they suddenly rush out and spend it instead. Likewise borrowing is already cheap – slightly lower rates will do little to encourage companies to take on more debt. It’s economic uncertainty, not the cost of financing, which is putting businesses off investing at present.

QE is designed to bring gilt yields down, and to flatten the yield curve. However a look at current gilt yields tells you they are already extraordinarily low – what is the benefit of bringing them down further?

Mark Carney has rightly pointed out that monetary policy can only do so much. This lays the gauntlet down for the chancellor to apply some fiscal stimulus when it comes to this year’s Autumn Statement. Gilt yields are so low that the government can borrow at next to nothing, which could pave the way for investment in infrastructure projects like an extra runway at Heathrow.


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