Posted by

Vicky Pryce

10 Aug 2016

The 0.25 per cent cut from 0.5 per cent, itself already a record low, finally came in early August, a month later than the market had anticipated.

It was the first move in interest rates by the Bank of England in six years. Indeed, the interest rate cut is just one part of a wider set of measures the Bank has enacted over the past few months, and governor Mark Carney has so far been the only major UK policy-maker to come forward with specific actions to stabilise financial conditions.

In the run up to the Brexit vote, for example, there was fresh injection of liquidity to calm markets, which had been feeling considerably jittery pre-referendum. Then, as banks came under the spotlight as soon as the result was clear, Carney was the one who addressed the nation on the early morning of 24 June before the London markets opened, making it clear that there was a £250bn fund he could deploy to ease any liquidity crisis faced by the UK financial system. The banks have remained under pressure but the general stock market recovery that followed owed a lot to his offer of generous support and the realisation that interest rates (and hence the pound) would stay low for longer or even fall further.

Interesting to think that until a couple of months before the Brexit vote, the next move in interest rates was meant to be up as the economy was recovering strongly. There was a bit of a pause as uncertainty set in near the date of the vote itself, but nevertheless second quarter GDP grew at 0.6 per cent, up from 0.4 per cent in the first quarter, as manufacturing benefited from a weaker pound.

All that changed. The shock of the vote sent the pound sharply lower and action was needed. Business surveys, such as the BCC’s Quarterly Economic Survey, were already indicating a pause in investment and expansion plans in the second quarter, and those were reinforced by post-Brexit survey data that suggested sharp declines in business and consumer confidence. Sterling's sharp fall may be good for exports in the longer term but manufacturing input costs are rising and consumers are already facing higher prices for many goods and services.

In July the governor postponed next year's scheduled raising of the banks' counter-cyclical capital buffer. That will potentially release a further £150bn that could be used for lending instead should business want it. And the August rate cut may not be the last one as the MPC seems to be prepared to cut again if necessary. Its action has been accompanied by extra measures, including a resumption of quantitative easing with an extra £60bn of government bond purchases and the buying of £10bn of eligible corporate bonds. In addition, the government is resuming what is essentially the old Funding for Lending programme, which allows banks to borrow at the Bank Rate of 0.25 per cent and lend to companies and individuals to ensure there is no issue around lack of availability of funds. And the Bank is now pushing lenders to pass the interest rate cut onto businesses and individuals.

Of course, none of this is particularly good news for banks in the short term as low interest rates are in general bad for profitability. And savers will lose out as interest rates fall and pension deficits increase as bond yields decline.

Fixing the economy is not cost free. But as Mark Carney said it is better to restore confidence and achieve some growth. Even so, despite this stimulus, the Bank is now forecasting very little expansion for the rest of 2016 and growth of just 0.8 per cent next year compared to 2.3% before. The economy then recovers to just 1.8% in 2018 with unemployment rising over the period to 5.5% from the present 4.9%.

Vicky Pryce is an economist, and member of the BCC's Economic Advisory Group