Bank of England lowers interest rate to 0.25 pct and expands QE

The Bank of England has lowered the interest rate to record low on Thursday, the first rate cut since 2009. The Monetary Policy Committee members unanimously decided to cut the Bank Rate to 0.25 percent from 0.50 percent. The MPC also voted for additional measures to give support to economic growth.

The measures include buying of up to GBP 10 billion of UK corporate bonds, expansion of the asset buying scheme for UK government bonds to GBP 60 billion, taking the total stock of asset purchases to GBP 435 billion. The central bank also introduced a new Term Funding Scheme to strengthen the pass-through of the cut in Bank Rate.

The central bank’s post meeting statement noted that the exchange rate has fallen and the short to medium term growth outlook has subdued noticeably after the Brexit vote. The central bank projects the sterling’s depreciation to push the CPI inflation up in the near term, accelerating its return to the 2 percent target rate. It anticipates the inflation to accelerate above the target in the latter part of its forecast period.

Meanwhile, the BoE expects near-term weakness in demand to open up a margin of spare capacity, including an eventual increase in unemployment. The BoE, in its statement, said that consistent with this, “recent surveys of business activity, confidence and optimism suggest that the United Kingdom is likely to see little growth in GDP in the second half of this year”.

The central bank continues to project the economy to expand 2 percent in 2016, but it forecasts just a 0.8 percent of growth in 2017. The bank had earlier projected the economy to expand 2.3 percent in 2017. The 2018 economic growth is now anticipated to expand modestly at a pace of 1.8 percent.

“Importantly, the Bank sees almost no growth in the second half of 2016, though does not see a recession as its central forecast, averted in part thanks to the aggressive action announced today. However, unemployment is set to rise to 5.6 percent in two years’ time, up from a projection of 4.9 percent made in May”, said Markit Economics Chief Economist Chris Williamson.

Meanwhile, the BoE now projects inflation to accelerate to 2.4 percent in two years’ time, mainly due to increased import prices resulting from the weakening of sterling.

“However, more action may well be needed, and not just from the Bank of England”, added Williamson.

According to a Nordea Bank research report, monetary policy is not expected to fully counter the negative impacts of Brexit despite the BoE’s aggressive monetary policy response today. The MPC’s statement strongly signals at one additional rate cut to close to zero before the end of 2016, added Nordea Bank.

“Regarding QE, we now expect no further expansion of the BoE’s asset purchases after today’s significant move, assuming our forecast of “only” a mild UK recession proves right”, added Nordea Bank.