Why The Bank Of England Had To Act

monetary policy commiteeSince the 2008 banking crisis, when the Bank of England rode to the rescue by loosening monetary policy, it has been preparing for the day the economy was ready for interest rates to return to normal. But then last Friday, they announced measures designed to ward off a Brexit induced economic slump.

What The Bank of England Announced

After seven years of no change, the Monetary Policy Committee had to do something that they weren’t expecting even a few months ago—to cut the benchmark lending rate to a new all-time low of 0.25%, from 0.5%.

Other measures announced include more purchases of government and corporate bonds for cash and a new funding scheme for banks.

The Bank of England governor, Mark Carney said in his press conference to announce the interest rate change

“The decision to leave the European Union marks a regime change. The economic outlook has changed markedly, with the largest revision to our GDP forecast since the Monetary Policy Committee was formed almost two decades ago.”

Before we look at the data that led the committee to make the change, it’s worth taking a moment to reflect on how momentous this is. Since March 2009, until last Friday, the Bank of England’s benchmark interest rate sat unchanged at 0.5%, the lowest in the institution’s 300-year history. As this chart shows.

uk interest rate movements

Over the past three years, Mark Carney has been preparing us for an increase in the rate, a removal of the unprecedented stimulus enacted as the global economy teetered in 2008 and 2009. As recently as May 2016, the minutes of the Monetary Policy Committee said

“The MPC judged it more likely than not that Bank Rate would need to be higher at the end of that period than at present in order to return inflation to the target in a sustainable manner.”

Why The Bank of England Acted

Following the Brexit vote, the Bank of England’s own data shows economic growth is projected to “slow markedly” over the rest 2016. But the central forecast in its latest inflation report (pdf) does not assume that the economy will fall into recession.

As we showed in our recent article, Confidence In The Global Economy, there are many reasons to be optimistic about the economic outlook, not least because the Bank of England has been proactive in stopping the economy stall. But a word of caution, even the Bank’s economists recognise uncertainty around its forecast is greater than usual.

The Bank of England believes that its actions will help inflation return to the Bank’s 2% target in the second half of 2017 and then rise above it temporarily. While pressure on inflation from within our economy is going to be minimal, the Bank thinks the weak Pound will mean we are likely to import some inflation.

The Bank says sterling is now 15% below its November peak, and around 10% below the path they had assumed in May. Import prices could increase by 10% by next summer. This is especially true for commodities such as oil and food, even if the price of these items doesn’t change.

Other Indicators To Look Out For

Wages have grown slowly, despite record low unemployment. The Bank data shows wage growth has been weak since the financial crisis and remained below its pre-crisis average, despite picking up in recent years.

The National Living Wage, that came into effect in April, will only have a limited effect on salary growth. The Bank’s research suggests it is being offset by companies reducing other aspects of pay such as overtime payments.

The Bank expects unemployment to be higher than the Bank assumed in May. The unemployment rate is expected to have risen already in July and continue to do so until 2018. Bank governor Mark Carney said unemployment was likely to rise by 250,000 so that is why it was right to take action now. Whatever the cost to savers and those retiring soon.

If you’re concerned about how the economic outlook will affect you, start making your Brexit Financial Plan by clicking here.

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