Carney’s monetary policy to the rescue? Let’s be honest, probably not
As was expected by most market watchers, the Bank of England has reacted to the poor PMI and the weakening economic outlook since the referendum by taking several decisive actions today.
However, it is right to be sceptical about the success of these measures and question whether the Bank's actions will be suited to support the economy in a noteworthy way going forward.
In a unanimous vote this morning, the Bank's Monetary Policy Committee decided to cut the key policy rate from 0.5 per cent to 0.25 per cent – a new all-time low in the Bank's 322-year history.
Additionally, the Bank hinted that a further cut to zero per cent until the end of 2016 is very likely.
On the quantitative easing front, the current budget for government bonds purchased was increased by £60bn to £435bn, while a further £10bn has been earmarked for corporate bond purchases (though this was approved by a narrower 6:3 majority).
In another move, the Bank launched a new Term Funding Scheme to offset some of the negative effect the rate cut will bring for banks.
So far, so good – or so it would seem.
Unfortunately, monetary policy close to the zero bound only has very limited effects, as seen over the past years across the globe.
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Even the Bank of England realises that its measures taken today will not be sufficient to prevent an economic downturn – hence its reduction in real GDP growth forecasts, and increase in inflation and unemployment estimates.
While, in theory, the interest rate cut will stimulate aggregate demand, the ongoing high level of uncertainty, caused by the pro-Brexit referendum will continue to weigh on credit demand of both households and companies.
These elevated levels of uncertainty are likely to persist over the next 30 months until a Brexit-deal has been finalised, thereby 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.
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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 powder dry for the months ahead (when the full impact of the Brexit vote will be clearer), additional measures, beyond the already hinted further rate cut, seem possible.
Regardless of today's decisions (which were expected by many), a GDP growth prediction of 0.4 per cent for the next year – below the Bank's revised prediction of 0.8 per cent – still seems most likely.