BoE’s sledgehammer stimulus - ING

James Knightley, Senior Economist at ING, notes that the Bank of England has cut rates and restarted its QE programme and despite being substantial in scope and scale, its effectiveness at averting a recession is questionable.

Key Quotes

“We see it as a stop-gap solution to show authorities are doing something ahead of more substantial fiscal support later in the year.

Ahead of the meeting we expected the BoE to cut rates 25bp and expand QE by £50-75bn together with a kick start to the funding for lending scheme. The outcome is a 9-0 vote in favour of that 25bp rate cut while there was a 6-3 vote in favour of a £60bn QE expansion, taking the size of the Asset Purchase Facility up to £435bn, plus the purchase of up to £10bn of corporate bonds (approved 8-1). The BoE is also introducing at “new Term Funding Scheme”, which will be designed to “reinforce the pass-through of the cut in Bank Rate”. MPC members Weale, Forbes and McCafferty dissented on QE, arguing that surveys may be overstating the economy’s weakness.

BoE officials had suggested we should be looking for some substantial action and it has been delivered. While acknowledging that sterling’s fall will push up inflation, the weaker growth outlook will diminish medium-term inflation risks. Consequently, BoE action “should also ensure that inflation does not fall back below the target beyond the forecast horizon”.

Indeed, today’s policy announcements are unlikely to be enough to prevent the UK from entering a technical recession. The steep decline in business surveys (PMIs suggest a 0.4%QoQ contraction in 3Q GDP) and plunge in confidence is unlikely to be reversed anytime soon given the prolonged period of Brexit related uncertainty that the UK faces. Indeed, BoE Governor Carney stated that the BoE can't fully offset this large structural shock in the press conference.

The effectiveness of monetary policy to tackle this issue is questionable, as has been acknowledged by MPC members. The greater prevalence of fixed rate mortgages weakens the stimulus from lower rates, while also hurting the incomes of those reliant on income from savings. The Statement also highlights the fact that “it is likely to be difficult for some banks and building societies to reduce deposit rates much further, which in turn might limit their ability to cut their lending rates”. This is why they are introducing the new Term Funding Scheme in order to provide additional funding to banks at “close to Bank Rate” to better allow the effects of the rate cut to be passed onto households and businesses.

Ahead of this meeting, some critics had argued that extra QE would have undesirable effects in the form of increasing inequality as wealthier people own the assets, while also potentially pushing some businesses to top up pension funds, dues to lower gilt yields, at the expense of capex investment. However, on balance, the Bank thinks the positives from this form of stimulus outweighs the costs. They state that it can boost credit to the economy while the corporate bond purchases “could stimulate issuance in sterling corporate bond markets”, all of which would lower borrowing costs and improve credit availability.

The BoE go on to signal that further easing is likely with a “majority of members” expecting rates to be cut to its “effective lower bound”, currently judged to be “close to, but a little above zero”. We think this will happen in November (to around 0.05-0.1%) with QE eventually pushed up to total around half a trillion pounds.

The focus will then shift to the government’s response with the new Chancellor, Phillip Hammond, today welcoming the BoE’s decision. He has already stated that the government could “reset fiscal policy if we deem it necessary”. We suspect it will happen at the Autumn Budget Statement, most likely in the form of greater infrastructure investment financed by borrowing to try and improve the productive potential of the UK economy.”