The Bank of England lowers the Bank Rate to 0.25% and announces a series of policies intended to boost the economy’s monetary stimulus.

Monetary Policy Update

The Bank of England’s Monetary Policy Committee (MPC) is responsible for setting monetary policy to achieve a 2% inflation target while supporting economic growth and employment. Following its meeting on August 3, 2016, the MPC implemented a set of measures aimed at providing additional support for growth and ensuring a sustainable return of inflation to the target. These measures include:

1. A 25 basis point cut in the Bank Rate to 0.25%.
2. Introduction of a new Term Funding Scheme (TFS) to reinforce the transmission of the rate cut to households and businesses.
3. Purchase of up to £10 billion of UK corporate bonds.
4. Expansion of the asset purchase scheme for UK government bonds by £60 billion, bringing the total to £435 billion. These purchases will be financed by central bank reserves.

Brexit Impact

The decision to implement these measures was influenced by the United Kingdom’s vote to leave the European Union. This decision resulted in a weaker exchange rate and a downward revision of short to medium-term growth prospects. The fall in sterling is expected to increase Consumer Price Index (CPI) inflation temporarily, with the potential for inflation to temporarily exceed the 2% target in the medium term. The real economy is likely to face near-term demand weakness, leading to a margin of spare capacity, including potential increases in unemployment. Recent business surveys indicate limited GDP growth in the second half of the year.

Balancing Act

The MPC faces a trade-off between achieving the inflation target and stabilizing economic activity. Given the projected demand weakness relative to supply, the MPC believes it is appropriate to provide additional stimulus to the economy, which may lead to temporary above-target inflation. This action aims to reduce spare capacity over time, ensuring inflation remains close to the target beyond the forecast horizon.

Monetary Instruments

The MPC’s choice of instruments considers their impact on the real economy and inflation. The cut in Bank Rate will reduce borrowing costs, but near-zero interest rates may limit banks’ ability to reduce lending rates further. To address this, the MPC introduces the TFS, providing funding to banks at rates close to Bank Rate, ensuring effective transmission of rate cuts. Expanding the asset purchase program for government bonds will lower yields on securities, impacting borrowing costs for households and businesses. It may also prompt portfolio rebalancing into riskier assets, increasing credit supply. Corporate bond purchases could provide more stimulus than equivalent gilt purchases, encouraging investment in corporate assets and stimulating sterling corporate bond markets.

Outlook

With these measures, the MPC expects unemployment to decrease and spare capacity to be absorbed over the next three years, while inflation remains slightly above the 2% target. While there is still a cumulative output gap, monetary policy can provide support during the economic adjustment process.

Additional Actions

The MPC retains the option to take further actions if necessary. These actions could include lowering Bank Rate further, expanding the TFS, or increasing the scale and variety of asset purchases. A majority of MPC members anticipate supporting a further cut in Bank Rate to its effective lower bound, which is close to, but slightly above, zero if data align with forecasts.

Unanimous Agreement

All MPC members agree that policy stimulus is warranted at this time. Bank Rate has been reduced to 0.25% and is supported by the TFS. An eight-member majority supports the corporate bond scheme, and six members favor further government bond purchases.

Supportive Measures

These measures are complemented by other supportive actions, such as reducing the countercyclical capital buffer, excluding central bank reserves from the exposure measure, offering indexed long-term repo operations, and smoothing the transition to Solvency II for insurers.

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