Last week the Bank of England announced a wide-ranging set of measures designed to support economic output and employment in anticipation of higher inflation and slower growth in the coming months; the Bank described the Brexit vote as “a very large identifiable supply shock”.
The measures announced today included a 25-basis-point cut to the policy interest rate, to 0.25%--the first rate change since 2009, taking the rate to its lowest point since the Bank’s founding in 1694. The Bank also expanded its Quantitative Easing (QE) programme.
Although it’s impossible to assess with any certainty the economic impact of Brexit, I would argue that the UK economy exhibits a number of structural risks, including issues around competitiveness, private-sector indebtedness, and weak public finances.
Looser monetary policy won’t necessarily have a direct impact on these structural issues. Central banks can provide a financial backstop in times of economic stress, but it’s more difficult for monetary policy to boost long-term growth. Along these lines, another measure announced today was the Term Funding Scheme (TFS) operated under the Asset Purchase Facility; the supply of finance is, after all, well within the control of a central bank. The TFS is designed, in the Bank’s words, “to reinforce the transmission of Bank Rate cuts to those interest rates actually faced by households and businesses by providing term funding to banks at rates close to Bank Rate.” It is specifically intended to support lending to consumers and businesses.
I noted with interest how many questions at the press conference associated with the announcement were about the possibility of the introduction of negative interest rates. (Governor Carney was adamant that they would not be adopted.) The very idea of negative nominal interest rates is hugely unorthodox; the notion of the “Zero Lower Bound” was long held as a fundamental economic principle. But now five central banks around the world—most prominently, the Bank of Japan and the European Central Bank—have embraced negative rates. This means that the idea is becoming normalised, and has less power to surprise. But this normalisation doesn’t change the fact that such unconventional policies represent a giant leap into the unknown, full of economic and political uncertainty. Beyond that, negative interest rates pose risks that are not uncertain—in the sense that we can already identify them. These have been written about at length in journals as well as in the media. For the financial sector, the most prominent risk is perhaps the effect on bank profitability arising from the squeeze on net interest margins. This is a particular issue for Eurozone banks; short-term and long-term loan growth in the Eurozone has been flat or negative for so long that banks are, in effect, having to cope with lower spreads on lower volumes.