BoE Surprisingly Maintains Rates at 0.5%, Expects Stimulus Measures in August

In a surprise move the Bank of England’s Monetary Policy
Committee overwhelmingly voted to maintain bank rates at 0.5% Thursday,
although it said it expects to take some stimulus measures in August.

At its meeting ending July 13, the MPC voted by a majority
of 8-1 to maintain bank rate at 0.5%, with one member, Gertjan Vlieghe voting
for a cut in bank rate to 0.25%, MPC says.

The Committee also voted unanimously to maintain the stock
of purchased assets financed by the issuance of central bank reserves at £375
billion.

“In the absence of a further worsening in the trade-off
between supporting growth and returning inflation to target on a sustainable
basis, most members of the Committee expect monetary policy to be loosened in
August” MPC says in a statement.

“The MPC is committed to taking whatever action is
needed to support growth and to return inflation to the target over an
appropriate horizon” it adds.

“The Committee discussed various easing options and
combinations thereof” and “the exact extent of any additional stimulus measures
will be based on the Committee’s updated forecast, and their composition will
take account of any interactions with the financial system.”

0.25% cut ‘almost
fully discounted by financial markets’

The decision to keep rates unchanged caught market players
off guard, as many had anticipated stimulus measures in response to the Brexit
vote would come sooner.

“Although economists were divided on the outcome, a
quarter-point cut in Bank Rate was almost fully discounted by the financial
markets” says Adam Chester, head of economics at Lloyds Bank Commercial
Banking.

“The decision therefore came as something of a
surprise” although it “looks no more than a
temporary delay” he says.

“The surprise today is reflected in the pound’s
knee-jerk 2% spike against the US dollar to $1.3470” says Nawaz Ali, UK
Currency Strategist at Western Union Business Solutions.

“We could even see a rise to $1.35 over the coming
weeks” he says.

“But BOE stimulus will come, eventually, and therefore
we still see sub-$1.30 as a more likely destination for cable by Q4 2016,”
he adds.

“Whilst not mentioned due to the Bank’s independence,
the swift appointment of a new PM is likely to have affected the bank’s
decision due to the stability Theresa May hopes to bring,” comments Ana
Thaker, Market Economist at PhillipCapital UK.

“Sterling rallied up to 1.34 but there is downside risk
for the currency targeting the week’s range around the 1.32 level” she says,
adding that “equities have taken a downturn as expected but will likely resume
at previous levels with monetary policy still accommodative and likely to
remain so for the foreseeable future.”

“While a policy adjustment may indeed be forthcoming in
August, it also seemed a July cut would have been counterproductive and a waste
of critical ammunition with markets already calming down in recent days”
pointed out Joel Kruger, FX Strategist at LMAX Exchange.

On the other hand, “the base assumption is that we see a
rate cut in August, but “policy loosening” is more likely to focus on
quantitative easing” SaxoBank’s head of FX strategy, John Hardy, says.

UK financial system
showed ‘improved resilience’

The MPC notes that as a consequence of the UK’s vote to
leave the EU, sterling effective exchange rates have fallen by 6%, and
short-term and longer-term interest rates have declined.

Reflecting changing sterling levels, financial market
measures of inflation expectations have risen moderately at short-term horizons
and have fallen slightly at longer horizons, it says.

“Markets have functioned well, and the improved
resilience of the core of the UK financial system and the flexibility of the
regulatory framework have allowed the impact of the referendum result to be
dampened rather than amplified,” the MPC says.

Meanwhile, the effect of the vote on households and
companies sentiment is starting to be seen, with businesses beginning to delay
investment projects and recruiting decisions and the housing market showing a
“significant weakening in expected activity”.

“Taken together, these indicators suggest economic
activity is likely to weaken in the near term,” the MPC notes.

Twelve-month CPI inflation was 0.3% in May and remains well
below the 2% inflation target, with the shortfall mainly due to “unusually
large drags from energy and food prices, which are expected to attenuate over
the next year,”
theMPC says.

“In addition, the sharp fall in the exchange rate will, in
the short run, put upward pressure on inflation as the prices of
internationally traded commodities increase in sterling terms, and as importers
pass on increases in their costs to domestic prices.”

Looking further forward, the MPC expects that  “a range of influences on demand, supply and
the exchange rate could lead to a significantly lower path for growth and a
higher path for inflation” than what set out in the Committee’s May inflation
report.

The MPC will release its new inflation forecasts in its
August report, due August 4.

Beatrice Bedeschi

beatrice@profit-loss.com

Twitter@Profit_and_Loss

Beatrice Bedeschi

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