U.K.'s Outlook Has Changed. The Bank of England Hasn't (Yet)
The Bank of England left rates on hold Thursday even after its governor, Mark Carney, said on June 30 that the U.K. decision to quit the European Union meant that "some monetary policy easing will likely be needed over the summer."
There are good arguments not to have cut borrowing costs at the first available opportunity. But there is one very compelling reason to inject more adrenaline into the economy as soon as possible.
The case for cutting rests on the outlook for gross domestic product after Britons voted to leave the EU. Here's what happened to economists' consensus forecast for growth since the June 23 referendum:
Instead of growth accelerating next year to an annual pace of 2.1 percent or better, which had been the expectation for more than a year, economists now see an expansion of less than 1 percent. The U.K. government's oft-repeated claim to top the Group of Seven growth tables will soon be nothing more than a fond memory.
But while the slumping GDP outlook would clearly justify lower rates, other forces may have prevented the central bank from cutting for the first time since March 2009. British banks are already in deep trouble as near-zero interest rates make it impossible for them, along with their European peers, to make money.
What's more, the one-time shock that Brexit dealt to the value of the pound implies inflation may finally stir as consumers pay more for imported goods. And the new government line-up following David Cameron's resignation looks more likely to approve fiscal measures to avert a recession, easing some of the burden on monetary policy to rescue growth.
Philip Hammond, the newly appointed chancellor of the exchequer, said on Thursday that Brexit had "rattled confidence," making him willing to take "whatever measures" are needed to reassure businesses and investors. His boss, Theresa May, the new prime minister, in a June 30 campaign speech had already scrapped her predecessor's commitment to run a budget surplus by 2020.
It's the third time the Conservative Party has breached its fiscal promises; it previously made a legally binding commitment to turn a budget deficit of 4 percent of economic output last year into a surplus of 0.5 percent by 2020. Hammond has already rescinded the threat made by his predecessor, George Osborne, to introduce a post-Brexit emergency budget, though Hammond declines to comment on Osborne's proposed corporate-tax cut.
Tempering the Treasury's enthusiasm for austerity is a sensible move as consumers and businesses adapt to the post-vote environment. Taking advantage of 10-year U.K. borrowing costs, which are at the lowest level ever, to fund much-needed infrastructure projects would help even more.
In explaining today's monetary-policy stasis, the Bank of England specifically pointed to the pound's drop against the U.S. dollar, to about $1.34 from as high as $1.50 on the eve of the referendum, as a cause for concern:
The sharp fall in the exchange rate will, in the short run, put upward pressure on inflation as the prices of internationally traded commodities increase in sterling terms, and as importers pass on increases in their costs to domestic prices.
All in all, the Bank of England was probably correct to pause on rates this week. But it will also probably follow its own prediction -- it said "most members of the committee expect monetary policy to be loosened in August" -- even though its track record on supplying forward guidance isn't exactly great.
Carney was dubbed an "unreliable boyfriend" by U.K. politician Pat McFadden two years ago for giving undependable guidance on when interest rates might rise. His perceived capriciousness, though, has more to do with just how uncertain the economic backdrop has become than with inconsistency on the part of the central bank. I, for one, am glad I'm not charged with trying to set monetary policy when the global economy rides on such shifting sands.
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