Bank of England cuts Bank Rate by 0,25% to stave off Brexit effects

04 Aug 2016


Mark CarneyThe Bank of England on Thursday announced a 25 basis point reduction in its policy rate, bringing the Bank Rate down from 0.50 per cent to 0.25 per cent in a move to save the economy from the shock of Britain's vote to leave the European Union.

Besides the interest rate cut to near zero level, unleashing billions of pounds to the economy, the British central bank also announced a £60 billion ($79 billion) government bond buying programme with newly created money over the next six months.

It also launched two schemes, one to buy 10 billion pounds of high-grade corporate debt and another - potentially worth up to 100 billion pounds - to ensure banks keep lending even after the rate cut.

The Bank of England said its monetary policy committee (MPC) cut the policy rate by 0.25 per cent to meet the 2 per cent inflation target, and in a way to help to sustain growth and employment. 

At its meeting ending 3 August 2016, the MPC voted for a package of measures which include a 25 basis point cut in Bank Rate to 0.25 per cent, a new term funding scheme to reinforce the pass-through of the cut in Bank Rate, purchase of up to £10 billion of UK corporate bonds and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of these asset purchases to £435 billion. 

BoE said the last three elements of monetary policy will be financed by the issuance of central bank reserves.

BoE noted that the exchange rate of the pound sterling had fallen after United Kingdom's vote to leave the European Union, and the outlook for growth in the short to medium term has weakened markedly. 

The fall in sterling itself is likely to push up CPI inflation in the near term, hastening its return to the 2 per cent target and probably causing it to rise above the target in the latter part of the MPC's forecast period, before the exchange rate effect dissipates thereafter, BoE said. 

In the real economy, however, the weaker medium-term outlook for activity largely reflects a downward revision to the economy's supply capacity - near-term weakness in demand is likely to open up a margin of spare capacity, including an eventual rise in unemployment. 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, BoE stated.

BoE expects a trade-off between delivering inflation at the target and stabilising activity around potential. Given the extent of the likely weakness in demand relative to supply, the MPC judges it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation.

This, according to the committee, will not only help to eliminate the degree of spare capacity over time but, because a persistent shortfall in aggregate demand, would pull down on inflation in the medium term. It should also ensure that inflation does not fall back below the target beyond the forecast horizon. Thus, in tolerating a temporary period of above-target inflation, the committee expects the eventual return of inflation to the target to be more sustainable.

The Bank said most BoE policymakers expected to cut the rate to even closer to zero later this year.

"By acting early and comprehensively, the (Bank) can reduce uncertainty, bolster confidence, blunt the slowdown and support the necessary adjustments in the UK economy," BoE Governor Mark Carney told a news conference.

Sterling fell 1.2 per cent against the dollar following the announcement, while British government bond yields hit record lows and the main share index rose by nearly 2 per cent.

Carney said he had unveiled an "exceptional package of measures" because the economic outlook had changed markedly following the Brexit vote. The Bank expects the economy to stagnate for the rest of 2016 and suffer weak growth next year.

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