Stimulus, Stimulus, Stimulus
A unanimous vote by The Monetary Policy Committee (MPC) heralds the introduction of the biggest monetary stimulus package since the financial crisis, accompanied by the cutting of interest rates to 0.25%. This is the Bank of England’s (BoE’s) first response to the Brexit vote, which according to woeful survey data and deep-seated market uncertainty is slowly starting to pinch. Although the BoE’s announcement will undoubtedly be welcomed by some, bankers and businesses will need to read the small print as these measures are heavily caveated. In reality, Carney hasn’t gone far enough:
- £70bn bond buying programme
The promise: The BoE will purchase £10bn of sterling-denominated investment-grade corporate bonds.
The catch: Only companies judged to make a “material contribution” to the UK economy will be eligible. The remaining £60bn is set aside for government debt.
- £100bn funding scheme for banks
The promise: Banks will be able to borrow from official BoE reserves at close to the base rate.
The catch: Banks will need to commit to lending to consumers and businesses at reduced rates in order to be eligible.
The stimulus package is aimed at minimising the impact of an impending economic downturn, during which some analysts predict that 250 thousand people will lose their jobs and bank growth will drop to just 0.5%*. This pessimism is echoed in the minutes of the MPC’s meeting which highlight the, “scope for further action” by the BoE, and stress the fact that, “a majority of members expect to support a further cut in the bank rate”. This is a clear declaration that Mr Carney intends to meet the Brexit backlash head on, instilling economic confidence through decisive action. However, cutting interest rates is not the best approach, especially when they were already at a record low. As the base rate approaches zero, the margin between the banks’ lending rates and saving rates is squeezed (unless saving rates they go negative, which is less desirable still). The upshot: banks’ profits suffer, they will become less likely to lend, and credit dries up.
The markets’ response to the stimulus has been varied. In the days following the announcement the FTSE 100 and FTSE 250 equity indices rose 1.5 per cent, and two of the biggest UK high-street banks (Santander UK and Barclays) announced cuts to their standard variable rate mortgages. However, British government bond yields continued to fall (10 year gilts dropped 16 basis points to 0.63%) and the pound fell 1.5% against the dollar. Evidently, despite his best efforts, the underlying message of stagnant growth, falling house prices, unemployment and inflation was what had the strongest effect on the market. This is only reinforced by the BoE’s failure to find sufficient buyers for its gilt-purchase programme, falling £52mn short.
The outlook of post Brexit-Britain is bleak. Whilst the BoE has taken the first steps towards combating the economic fallout of the historic vote, the success of its efforts depends on the appetite and ability of banks to make the most of this new stimulus package, ensuring that true savings are passed down to their customers. It is of course possible (if unlikely) that banks will simply use the drop in interest rates to increase their margins, thereby undermining efforts to keep British consumers spending and British banks lending. Furthermore, if the stimulus is to succeed then mortgage rates will need to decrease in line with the projected decline in house prices, and investment in British business must be bolstered to mitigate the impact of looming unemployment. However, banks can only do so much. Lack lustre monetary policy will stifle the economy further as we stare recession in the face, and the British taxpayer once again risks having to pay the price for its mismanagement.
*as an annual % change in real GDP.