Monetary policy to the rescue? Probably not
As expected by most market watchers, including Dun & Bradstreet, the Bank of England has reacted to the poor PMI figures and the generally weakening economic outlook over the past weeks after the Brexit referendum and taken several actions today. In an unanimous vote, the Bank’s Monetary Policy Committee decided to cut the key policy rate from 0.5% to 0.25%, a new all-time low in the Bank’s 322-year history. Additionally, the Bank hinted that a further cut to 0% until the end of 2016 is very likely. On the Quantitative Easing front, the current budget for government bonds purchases was increased by GBP60bn to now GBP435bn while a further GBP10bn were earmarked for corporate bond purchases (which was approved by a narrower 6:3 majority). Furthermore, the Bank launched a new Term Funding Scheme to offset some of the negative effect the rate cut will bring for banks.
The key question now is if the Bank’s actions will be suited to support the economy in a noteworthy way going forward. Unfortunately, Dun & Bradstreet is skeptical about the success of these measures as monetary policy close to the zero bound only has very limited effects, as seen over the past years across the globe. Even the Bank of England realizes that its measures taken today will not be sufficient to prevent an economic downturn, it has hence reduced real GDP growth forecasts and increased inflation and unemployment forecasts. While, in theory, the interest rate cut will stimulate aggregate demand, the ongoing high level of uncertainty, caused by the Brexit referendum will continue to weigh on credit demand of both, households and companies. These elevated levels of uncertainty are likely to persist over the next 30 months until a Brexit-deal has been finalized, thereby undermining the positive effects of further monetary easing.
While investment is unlikely to respond in a noteworthy way, the biggest positive impact on the British economy could stem from the exchange rate channel as UK-based exporters should benefit from a further depreciation of the pound against the dollar and the euro. However, the effect of this will also be limited as the UK is largely dependent on its sizeable service sector whose products are more difficult to trade than manufactured goods. In addition, imported inflation (which will come in above the target rate in 2017) will reduce living standards in the UK.
With the Bank having kept some of its powder dry for the months ahead (when the full impact of the Brexit vote will be clearer), additional measures, beyond the already hinted further rate cut, seem possible. Regardless today’s decisions (which were expected and had been factored in our forecast already) Dun & Bradstreet sticks to its real GDP growth prediction of 0.4% for next year (below the revised 0.8% of the Bank of England) as well as our 2.4% inflation forecast. However, we are prepared to adjust our projections over the next weeks when new post-Brexit high-frequency data, including our own proprietary data is released.