Dr. Lorenz Weimann
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As expected, the BoE lowered its base rate from 0.5% to a new all-time low of 0.25%. In addition, it expanded its asset purchase program by GBP 70bn and announced that it would now also be buying corporate bonds. To cushion the negative effects of low interest rates on the banks, the Funding for Lending Scheme has been reactivated. All told, the measures will swell the BoE’s balance sheet by up to GBP 170bn.
The markets welcomed the scale and breadth of the package. The interest rate cut, the first in more than seven years, had been fully priced in by the markets, not least because the prospect had already been raised at the last monetary policy meeting three weeks ago. By contrast, the expansion of the QE program exceeded market expectations. The BoE announced that it would not only be buying government bonds to the tune of GBP 60bn but also GBP 10bn worth of UK corporate bonds.
The scale of the package shows that the BoE expects Brexit to have a very negative impact on the UK economy. The bank slashed its growth forecasts and now expects GDP growth in 2017 of only 0.8% (previously 2.3%). By contrast, given the expected rise in import prices, the inflation forecast for 2017 was lifted from 1.5% to 1.9%. Although hard data are not yet available, a host of leading indicators on business and consumer sentiment have been pointing of late to a marked slowdown in the economy. Particularly worrying is the slide in sentiment in the services sector, which accounts for almost 80% of economic output. The purchasing managers’ index for the services sector tumbled to 47.4 points in July, the lowest reading since the crisis year 2009.
The BoE is not biding its time with a cautious policy dosage to stabilize the UK economy, but has opted to confront a possible hard landing head on. Moreover, BoE Governor Mark Carney stressed that the bank was ready to take further measures should the economy develop even worse than currently expected. While these statements doubtless help to curb the mounting uncertainty in economic expectations, their impact on the real economy will be limited. It would also be advisable for the BoE to remain on hold in the coming months to allow today’s measures to feed through and be better placed to gauge the consequences for the UK economy. The UK’s departure from the EU is likely to be a drawn-out process marked by elevated economic uncertainty. The BoE would do well not to exhaust its arsenal right at the beginning of the journey but to keep some powder dry.