Will the Bank of England cut rates?

In the wake of the historic Brexit vote last month, Governor of the Bank of England, Mark Carney, has indicated that there may be a move to cut rates. When the Monetary Policy Committee meets this week and makes an announcement on Thursday, it may be to cut interest rates.

Mark Carney came under criticism with those on the leave side prior to the vote, as they believed he was too much in favour of support. However, he is now receiving praise from many for his swift response to Brexit, whilst the Politicians have been squabbling. He quickly indicated that a rate cut and an expansion to the asset purchase facility were actions that the MPC could take to help mitigate the negative impacts of Brexit. Many believe that they will do that this week.

The market has already priced in a 75% of a cut to 0.25% This would be a new record low for UK interest rates. Some are suggesting they could go straight to 0% rates as early this week, although most think it will be a little longer before we get to that level. There is also the possibility of more QE to help boost the economy. Again it is viewed as too soon for that by many. Indeed, Andrew Sentance an ex-MPC member, has called for patience until there is more data on what impact the referendum has had on the economy.

The MPC is looking to take these actions, to help stimulate slowing growth in the wake of the referendum, even knowing this may result in an overshoot of their inflation target. Given how low inflation has been for years, it seems unusual to talk of high inflation. It is the depreciating pound that could result in higher inflation above the 2% target, potentially even over 3% if the depreciation takes the Pound closer to parity with both the Euro and Dollar. A weak pound, makes imports more expensive with petrol and food amongst the first to be hit, this could make people feel the pinch in their pockets whilst there is a slowdown as well. Any monetary easing undertaken by the MPC will only exacerbate potential inflation, but just as they did in 2011 when inflation hit 5%, they will overlook this and see boosting the economy as more important than low inflation.

Basic macroeconomics says a low interest rate stimulates the economy, although such an impact is clearer when dealing with rates around 5%, not 0.5%. At these levels a cut in rates can have negative impacts. A cut in rates can often lead to a fall in the profitability of Banks. If Banks are underperforming, it is entirely understandable for them to reduce the supply of credit and therefore cause the interest rates at which they lend, to go up, the opposite to what the MPC would intend by lowering the base rate. Similarly, savers will lose out further than they already have done, this is currently happening to Germans, where potential billions have been lost to savers due to low rates, which has also potentially depressed the economy.

The Short Sterling market is largely pricing in a rate cut this week, and it doesn’t expect rates to be higher than they are currently by the end of the decade. This puts us in a similar boat to the Eurozone, where there appears to be no end in sight to low interest rates and other forms of easing.

The announcement at noon on Thursday could be historic, as it may see the base rate fall, to even lower levels as the MPC may take action to the base rate for the first time since 2009.

Picture courtsey of Bank of England via Flcikr

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Reuters: Business News