Bank of England Must be Agressive in Order to Avoid a Strong GBP Recovery
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With strong arguments against fresh Bank of England policy measures being introduced on the 4th of August, we see the balance of risks lying with a stronger British Pound against the Euro and US Dollar by the time the day is done.
Markets are pricing in at least a 25 basis point cut to the record-low 0.50% basic rate of interest at the Bank of England this Thursday.
The Overnight Indexed Swap markets are actually pricing in a 100% chance of a 25 basis interest rate cut.
The British Pound is therefore priced accordingly, and will likely retain a soft tone until the final outcome of Thursday’s decision is made known.
The intention of any action at the Bank would be to minimise the negative impact to the economy derived from the shock vote by the UK to leave the European Union in June.
There is also the question of whether the bank’s dormant quantitative easing programme will be resuscitated in order to further suppress the cost of borrowing.
“Note that while a 25bp rate cut this week is fully discounted into UK rates, but re-starting QE is not priced in and would likely be the catalyst for the next major decline in Sterling,” says a note on the matter from Citi Economics.
The hope by proponents of any action is that both the rate cut and increased quantitative easing will oil the financial cogs in the economy, thus ensuring downside pressures on growth are minimised.
However, questions have been raised as to just how effective the moves would be with some analysts suggesting cutting rates and boosting quantitative easing could do more harm than good.
We have already reflected on how the measures are likely to impact savers with major banks warning that charging savers to deposit money with them could become a reality.
Policy measures could also simply prove ineffective in achieving their stated aim of stimulating bank lending.
“With interest rates close to zero along much of the curve there is limited room for monetary policy to help. Moreover, unlike the financial crisis, the problem this time round is one of credit demand rather than supply,” notes Robert Wood, economist with Bank of America Merrill Lynch Global Research.
Banks are better capitalised this time around, so the BoE does not believe it is currently at the zero lower bound, and would therefore believe they have space within which to play with their knives.
The Zero Lower Bound is a problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity that the central bank has to stimulate economic growth.
Indeed, a rate cut will help only a little argues Wood:
“It may not be fully passed through to borrowers, or banks appetite to lend could be harmed. Other countries that have pushed rates to or below zero have seen negative effects. However there is likely to be some passthrough, meaning rate cuts will help a little.”
Other analysts are in agreement that there is little room to play.
Arnaud Masset at Swissquote Bank says he believes policy-makers will be best served by opting keep its powder dry.
“The BoE has limited room for manoeuvre before switching to negative interest rates. Therefore, we expect the central bank to leave its benchmark rate unchanged at its next meeting on August 4th, waiting for further information about the implication of Brexit for the UK economy,” says Masset.
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