As expected by most market watchers, including Dun & Bradstreet, the Bank of England has taken action today in response to poor PMI figures and the generally weakening economic outlook that has developed in the weeks since the Brexit referendum. In a unanimous vote, the Bank’s Monetary Policy Committee decided to cut the key policy rate from 0.5% to 0.25%, a new all-time low in the Bank’s 322-year history. Additionally, the Bank hinted that a further cut to 0% before the end of 2016 is very likely.
On the Quantitative Easing front, the current budget for government bond purchases was increased by £60 billion, to £435 billion, with a further £10 billion earmarked for corporate bond purchases (which was approved by a narrower 6-3 majority). Furthermore, the Bank launched a new Term Funding Scheme to offset some of the negative effect the rate cut will have on banks.
The key question now is whether the Bank’s actions will serve to support the economy in a noteworthy way. Unfortunately, Dun & Bradstreet is skeptical about the likely success of these measures, as monetary policy close to the zero-bound has only very limited effects, as has been seen around the globe in recent years. Even the Bank of England realizes that the measures it has taken today will not be sufficient to prevent an economic downturn: It has reduced its real GDP growth forecasts and increased its inflation and unemployment forecasts.
While in theory the interest rate cut will stimulate aggregate demand, the ongoing high level of uncertainty caused by the Brexit referendum will continue to weigh on credit demand from households and companies alike. These elevated levels of uncertainty are likely to persist over the next 30 months until a Brexit deal has been finalized, undermining the positive effects of further monetary easing.
While investment is unlikely to respond in a noteworthy way, the biggest positive impact on the British economy could stem from the exchange-rate channel, as UK-based exporters should benefit from a further depreciation of the pound against the dollar and the euro. However, the effect of this will also be limited, as the UK is largely dependent on its sizeable service sector, whose products are more difficult to trade than manufactured goods. In addition, imported inflation (which will come in above the target rate in 2017) will reduce living standards in the UK.
With the Bank having kept some of its cards unplayed for use in the months ahead (when the full impact of the Brexit vote will be clearer), additional measures beyond the already hinted-at further rate cut seem possible. Regardless of today’s decisions (which were expected and had already been factored into our forecast), Dun & Bradstreet is maintaining its real GDP growth prediction of 0.4% for next year (below the Bank of England’s revised 0.8% forecast), as well as our 2.4% inflation forecast. However, we are prepared to adjust our projections in the coming weeks as new post-Brexit high-frequency data, including our own proprietary data, are released.
Having previously worked for the European Parliament in Brussels, Markus Kuger joined D&B’s office in Marlow/United Kingdom in June 2010. In his role as Senior Economist in D&B Macro Market/Country Insight Products, he is writing about his home country Germany as well as the UK, France, the Netherlands, and Poland.