The Bank of England is worried about the possibility of a recession in the post-Brexit environment. Yesterday, it announced it would cut interest rates to stimulate Britain’s economy. From the earlier level of 0.5%, the official rate in Britain is now at the record-low level of 0.25%.
The central bank has cut interest rates the first time in more than seven years, and is expecting commercial banks in the UK to pass the low cost of borrowing on to the final customer. Chances are the central bank will opt for further easing as economic conditions worsen, especially with investors pulling their wealth out of the country.
The bank has said that a majority of the members of the Monetary Policy Committee (MPC) are expected to encourage a further rate cut this year if economic events unfold as expected. The rates could be brought down to as low as 0.1% and we must bear in mind that the bank is not in favor of negative interest rates.
Bank of England Governor Mark Carney is determined to pass on the benefit of lower interest rates to the general populace. He also understands that commercial banks are at a disadvantage when rates are lowered, and has granted additional funds for commercial banks to make up for the lost margin.
Several measures are needed to control job losses and support growth, especially during the next two years. The Bank of England believes even after steps that serve this purpose, citizens should expect the loss of around 250,000 jobs and relaxed earnings growth. The country's real GDP grew 2.2% in 2015, and Bloomberg analysts expect the same to grow 1.5%, 0.5% and 1.5% in 2016, 2017 and 2018 respectively.
Investor confidence took a nosedive after Brexit. The further sluggishness in consumer spending is likely to push the country towards recession. The quantitative easing plan announced by the central bank includes pumping an extra 60 billion pounds into the economy to purchase government bonds, thereby taking the current quantitative easing to 435 billion pounds in total.
The central bank also plans to buy corporate bonds of highly influential institutions. It has announced it will inject 10 billion pounds of electronic cash and introduced a new “term funding scheme” (TFS), under which commercial banks will be punished if they refuse to lend to any corporate or consumer client, as they benefit from newly created money.
An overview of major crisis-struck economies in the recent past makes it clear that monetary policy has its limits when it comes to countering a slowing economy, and the role of government is always crucial. Chancellor of the Exchequer Philip Hammond has praised the steps taken by the Bank of England and said: “Alongside the actions the Bank is taking, I am prepared to take any necessary steps to support the economy and promote confidence.” He also offered reassurance saying that the government possesses the tools and measures to support the economy in the current scenario.
Business Finance News believes the initiatives put in place are shrewd, but stakeholders must keep in mind that they will fall short of fully offsetting negative trends. The initiative may cushion the current slowdown but will not address the real problem; high uncertainty owing to pending final negotiations between the UK and EU authorities.
The people of the UK have increased saving (spending less) to guard against uncertainty. Investors on the other hand are retaining investment plans as they wait for the economy to settle down.
The Pound Sterling plunged 1.5% against the dollar within half an hour of the beginning of Mr. Carney's speech yesterday. The strong chance that the Bank of England will cut rates further in the short-term means traders will stay away from large positions in the Pound.
The Pound has managed to stay above the 31-year low of around $1.28 it touched about a month ago. It gained its lost value against the dollar in two of the last three weeks. Following the news of the cut yesterday, the FTSE 100 (index representing blue-chip stocks of UK) gained the most in the last five weeks, rising 1.6% and closing at 6,740.16.