The Bank of England has unleashed a massive stimulus package today as it warned growth in the UK economy will grind to a halt over the next 18 months.
In a dramatic move, the Bank’s monetary policy committee (MPC) voted unanimously to slash interest rates to 0.25 per cent while also unleashing a huge extension of quantitative easing which could pump an extra £170bn of newly-printed cash into the economy.
The Bank will use the money to buy another £60bn of government bonds along with £10bn of private sector debt, while lenders will be able to secure up to £100bn of cheap loans directly from Threadneedle Street.
The extension of quantitative easing will take the total stock of government debt held by the Bank from £375bn to £435bn and add another £10bn of private sector debt onto its balance sheet.
In a precipitous warning to markets, the MPC also said it was not finished yet. It expects interest rates will sink even lower before the end of the year.
Summary of Bank of England package
- Interest rates cut to 0.25 per cent - their lowest ever level in the Bank’s 322-year history
- Another £60bn of government bond purchases - taking the total stock to £435bn
- A new £10bn corporate-bond buying package, similar to the programme being undertaken by the European Central Bank (ECB)
- £100bn of cheap loans for banks to stimulate lending
The Bank said: “Following the UK’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short-to-medium term has weakened markedly.
“Confidence and optimism suggest that the UK is likely to see little growth in GDP in second half of the year.
“The package contains a number of mutually reinforcing elements, all of which have scope for further action. The MPC can act further along each of the dimensions of the package by lowering bank rate … and by expanding the scale or variety of asset purchases.”
The Bank said even with the largest stimulus package since the recession it expects the UK economy to freeze during the rest of the year, as it hacked its growth forecasts in the biggest single downgrade since it started publishing projections back in 1992. In new post-referendum forecasts published in the latest Inflation Report, the Bank now predicts the UK economy will grow by just 0.8 per cent next year, down from its pre-vote forecast of 2.3 per cent.
In total, number crunchers at the Bank believe the UK economy will be 2.5 per cent smaller by 2018 than it would have been had the UK stayed in the EU - a £45bn hit to GDP.
Bank of England forecasts
|GDP growth||2.0 per cent (unchanged*)||0.8 per cent (down from 2.3 per cent)||1.8 per cent (down from 2.3 per cent)|
|Inflation||0.8 per cent (unchanged)||1.9 per cent (up from 1.5 per cent)||2.4 per cent (up from 2.1 per cent)|
|Unemployment||5.0 per cent (down from 5.1 per cent)||5.4 per cent (up from 4.9 per cent)||5.6 per cent (up from 4.9 per cent)|
While it fell short of officially predicting a contraction, the spectre of a technical recession still looms large over the UK economy, the Bank warned, with growth is expected to tumble from 0.6 per cent in the second quarter to just 0.1 per cent in the three months to September, before falling dangerously close to zero at the end of the year.
The Bank put the chances of UK growth actually turning negative in 2017 at one in three.
It also said house prices will fall this year, inflation will edge ahead of its two per cent target by 2018 and unemployment will peak at 5.6 per cent within two years - up from a previous estimate of 4.9 per cent.
To super-charge the impact of the interest rate cut, and provide some welcome reprieve for the banking sector, a new system of cheap loans - a so-called Term Funding Scheme (TFS) - for banks was also unveiled. The TFS will allow banks to borrow directly from the Old Lady with the Bank prepared to print another £100bn of new cash to finance the scheme.
Unveiling the package Mark Carney said: “Had it not taken the action announced today, the MPC judges it likely that output would be lower, unemployment higher and slack greater.”
In a letter to Chancellor Philip Hammond where Carney stressed monetary policy would not be enough to protect the UK economy, he added: “The UK is a highly flexible, dynamic economy. These characteristics will help it move to a new equilibrium as its future relationship with the EU becomes clear and new opportunities with the world open up.”
Hammond pledged he was “prepared to take any necessary steps to support the economy and promote confidence.”
The decision marks the first cut to interest rates since March 2009. Carney added the MPC was willing to take rates as close as they could go to zero in the fight to protect the UK economy.
Minutes from the MPC meeting said: "If the incoming data provide broadly consistent with the August Inflation Report forecast, a majority of members expect to support a further cut in bank rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year. The MPC currently judges this bound to be close to, but a little above, zero."
What is the new Term Funding Scheme (TFS)?
The TFS is designed to help banks in the low interest rate environment while also promoting lending to the real economy.
Banks will be able to secure loans directly from the Bank of England, with Threadneedle Street printing money to finance the scheme. The total amount a bank can apply for will be initially capped at 5 per cent of their total loan book.
If every bank takes up its allocation, an extra £100bn of new cash will be pumped into the economy.
Loans will be offered at the Bank’s base rate - now 0.25 per cent - as long as banks total lending does not shrink. For every one percentage point a bank’s net lending falls, the costs of the scheme will rise by five basis points up to a maximum of 0.5 per cent.
The MPC hopes this will drive down borrowing costs and make sure the effects of the interest rate cut are felt in the real economy. The TFS is similar to the old funding for lending scheme but less convoluted as it involves direct monetary easing by printing more cash, rather than a complex exchange of guarantees and government debt.
The MPC said it had been designed to completely offset the pressure on profitability from lower interest rates.
What are the new quantitative easing measures?
The Bank will buy another £60bn of government debt in an extension to the £375bn it bought in the financial crisis. The purchases will take place over the next six months and will bring the Bank’s total holding of government debt to £435bn.
In addition to this, the Bank will also purchase around £10bn of private sector bonds. Companies that issue debt rated as investment grade. Banks and financial companies will be excluded from the programme and firms will have to demonstrate they have a material footprint in the UK - either through employment, a headquarters or substantial tax revenues - to take advantage of the scheme.
The programme will run over a longer period of time and is expected to take 18 months to run its course.