The 0.25 per cent cut from 0.5 per cent, itself already a record low, finally came yesterday, a month later than the market had anticipated.
It was the first move in interest rates by the Bank of England in seven years. I often wondered whether membership of the Monetary Policy Committee (MPC) wasn’t the best job in the world. A number of its policy members have done two term stints without raising or lowering rates at all. And as people have pointed out, none of the current MPC members were around when rates were last cut in 2009.
And yet their job should not be underestimated. If we escape a post-Brexit recession, it will be to a considerable extent due to actions by the Bank of England. 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.
Before 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.
But the initial response was not enough. 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. The household sector was borrowing strongly too.
All that changed. The shock of the vote sent the pound sharply lower and action was needed. Business surveys in the second quarter were already indicating a pause in investment and expansion plans, and those were reinforced by post-Brexit survey data that suggested sharp declines in business and consumer confidence. PMI data have suggested services, manufacturing and construction are all in decline. And the latest credit figures have pointed to weak business lending.
All this was confirmation that the expected sharp slowdown had begun.
A few weeks later, 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 yesterday’s 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 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.
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 deploying the money the Bank of England may make available to help businesses and consumers also means money diverted from other areas. Indeed, savers will lose out as interest rates fall and pension deficits increase as bond yields decline. Fixing the economy is not cost free. But it is better to restore confidence and achieve some growth. Even so, despite this stimulus, the Bank is now forecasting very little growth for the rest of 2016 and expansion of just 0.8 per cent next year, down from 2.3 per cent before.
That may still be too optimistic. But to get back to something more normal, we need much more. As the governor said, monetary policy cannot achieve structural changes to the economy or shift productivity trends. A reflationary Budget in the autumn is a must and it will come.