Sunday, August 07, 2016
The Bank's big guns won't stop us taking a hit from Brexit
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

You will forgive me, I hope, for being in a state of excitement since Thursday lunchtime. I cannot remember exactly what I was doing in March 2009, the previous time interest rates were cut. I can confirm I had fewer grey hairs back then. But, having sometimes despaired about whether I would ever see another interest rate change, the Bank of England duly delivered.

True, until June 23rd it seemed much more likely that the next rate rise would be up rather than down, though not yet. And true, we thought we had seen the last of quantitative easing (QE) from the Bank. Its invention of a new term funding scheme (TFS), intended to ensure that the rate cut from 0.5% to 0.25% gets fully passed on by the banks and other lenders, is another initiative that owes its life to the referendum result.

I’ll come on in a moment to the Bank’s measures, and whether they will work. Even without the additional QE and the launch of the TFS, however, it was clear that this rate cut was more controversial than most. Before it was announced, some former members of the Bank’s monetary policy committee (MPC) joined other pundits in arguing against it.

One tabloid newspaper which had supported Brexit aggressively bemoaned the fact that its elderly readers were about to be hit with a double whammy of lower interest rates on their savings and higher inflation. To which the answer is, they got what they voted for. Unless, of course, those older readers backed Brexit because they believed George Osborne’s warning that it would mean higher interest rates.

What were the arguments against cutting rates? One was that it is still early days, and that we do not yet know how big a negative hit to the economy the Brexit vote has caused, a question I put to Mark Carney at Thursday’s press conference. The answer, from his colleague, the deputy governor Ben Broadbent, was that the plunge in the composite purchasing managers’ index – the biggest monthly fall on record – provided the Bank with a pretty clear steer.

It would have been unthinkable in the past for the MPC not to respond to such a plunge in the PMI. Even aiming off slightly from it, as the Bank has done in its forecasts, produces an abrupt slowdown. Other evidence, from property and other sectors, pointed to the clear need for a stimulus. Bank insiders say a report from the Bank’s own agents was misreported as suggesting there was no negative Brexit effect on the economy.

The agents, as reported in Thursday’s inflation report, have found that the decision to leave will have a measurably negative impact on investment, hiring and turnover over the next 12 months. Above all, the Bank has to anticipate as well as respond to events. It anticipates a very sharp slowdown in the economy, so action was required. The referendum “regime change” described by Carney – hopefully a bit more successful than the one which got rid of Saddam Hussein – needs some heavy nurturing.

What about another argument, that this is a time, not for the Bank to squeeze the last drop out of what it can do on interest rates, but for the government to take up the baton with fiscal policy? Why not a big increase in infrastructure spending – taking advantage of already very low government borrowing costs – or tax cuts?

There may be a place for both of these things. Increasing infrastructure spending is easier to defend at a time of high levels of government borrowing than cutting taxes, because the so-called multiplier effects – the beneficial impact on growth and therefore government revenues – are larger. But infrastructure is the slow-moving tortoise of economic policy, while monetary policy is the hare. Over time, higher levels of infrastructure spending will be more beneficial to the economy than sustained near-zero interest rates. But as a short-term response to an immediate downturn it is pretty near hopeless.

The third objection to a rate cut was that it would squeeze margins at the banks and other lenders which, if not posing the kind of problems they encountered in 2008-9, might make them less willing to lend, and would make them reluctant to pass the rate cut on to households and businesses.

Though the Bank said 18 months ago that the “effective lower bound” for rates was no longer 0.5% but lower, the banks seem to have been slow to wake up to this. Fortunately for them, the Bank’s £100bn new funding scheme, the TFS, should deal with the problem. Banks that maintain or increase their borrowing will be able to borrow at close to Bank rate, implying funding costs well below those available in wholesale markets. It is the most imaginative aspect of the package of measures announced on Thursday.

Will it, the quarter-point rate cut, £60bn more of quantitative easing (taking the total to £435bn) and £10bn of corporate bond purchases, work? The Bank used its big guns because it thinks the economy needed it and also to show it has not run out ammunition. Another rate cut, to 0.1% or 0.05% (though not negative rates), is assumed by most MPC members before the end of the year. There could be additional QE. We have embarked on another leg of a monetary easing cycle that first began almost a decade ago.

Even with the Bank’s package, growth will slow to a crawl for the rest of this year and be very weak at 0.8% next year. Unemployment will rise by around a quarter of a million. Without it, the Bank thinks unemployment would have increased by half a million or more, with very little economic growth over the next 18 months.

Could the Bank’s actions backfire, by reducing rather than boosting confidence? Is there a danger that by drawing attention to the post-referendum weakness of the economy, it could add to uncertainty?

That danger has been greatly overstated. The downward revision to the Bank’s growth forecast for next year (from 2.3% to 0.8%) was the largest since it became independent in 1997. But importantly, the Bank offered reassurance that, with the right policies, the economy can be guided through these short-term difficulties without falling in to outright recession. That will still leave some substantial long-term difficulties, of course.

The Bank’s big guns will not fire up the economy but they will prevent a sharper slowdown than would otherwise have happened. The Bank has done its bit. It could not have done much more.