BoE Announces Brexit-Induced Stimulus Package

The Bank of England’s (BoE) Monetary Policy Committee (MPC) has voted unanimously in favour of a 25 basis point cut in Bank Rate to 0.25%.

It also voted for a new Term Funding Scheme to reinforce the pass-through cut in Bank Rate, up to £10 billion corporate bond purchases and an expansion of its asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion.

The BoE says that these last three measures will be financed by the issuance of central bank reserves.

In a statement issued today, the BoE notes that the UK’s vote to leave the European Union has caused the exchange rate to drop and the outlook for growth in the short to medium term to weaken “markedly”.

It says that the fall in sterling is likely to push up on consumer price inflation in the near-term, hastening its return to the 2% inflation target set by the MPC and probably causing it to rise above the target in the latter part of the MPC’s forecast period, before the exchange rate effect dissipates thereafter.

The BoE says that in the real economy, although the weaker medium-term outlook for activity largely reflects a downward revision to the economy’s supply capacity, near-term weakness in demand is likely to open up a margin of spare capacity, including an eventual rise in unemployment.

It cites recent surveys that concur with this expectation, with the results showing that the UK is likely to see little growth in GDP in the second half of this year.

In the statement, the BoE continues: “These developments present a trade-off for the MPC between delivering inflation at the target and stabilising activity around potential. The MPC’s remit requires it to explain how it has balanced that trade-off.

“Given the extent of the likely weakness in demand relative to supply, the MPC judges it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation.

“Not only will such action help to eliminate the degree of spare capacity over time, but because a persistent shortfall in aggregate demand would pull down on inflation in the medium term, it should also ensure that inflation does not fall back below the target beyond the forecast horizon.

“Thus, in tolerating a temporary period of above-target inflation, the Committee expects the eventual return of inflation to the target to be more sustainable.”

The BoE says that, had the MPC had not taken these actions today, then it is probable that UK output would decrease, unemployment would rise and the sustainable return of inflation to the committee’s target rate would have been jeopardised.

It adds that the package announced today contains a number of mutually reinforcing elements, “all of which have scope for further action”.

The statement concludes: “If the incoming data prove broadly consistent with the August Inflation Report forecast, a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year. The MPC currently judges this bound to be close to, but a little above, zero.”

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Galen Stops

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