NN Investment Partners has published an article on their view on the Bank of England cutting interest rates; the article is re-published here in full.

"The Bank of England (BoE) faces a trade-off between upward pressure on inflation exerted by the Sterling depreciation and downward pressure on growth momentum induced by the post-Brexit fall out. The latter is clearly becoming visible in consumer and business confidence data. For now the BoE has clearly chosen to look through the exchange rate induced rise in inflation because the central bank expects this to be temporary.

Meanwhile, the growth slowdown will cause the unemployment rate to rise which, taken in isolation, will over time start to exert downward pressure on inflation. The easing actions taken today are aimed at mitigating this growth slowdown and thus preventing inflation from falling below target once the exchange rate effect runs out of the inflation data. All this seems the right action to take given the fact that the risk to inflation expectations is if anything a bit to the downside.

• Much like other central banks, the BoE is clearly acutely aware of the potential negative consequences of lower and flatter yield curves on the business model of financial institutions and hence credit supply. For this reason action has been taken which mitigates the negative financial sector profitability consequences of the cut in the Bank rate and the increase in sovereign QE. The BoE introduced a Term Funding Scheme which should help lower bank funding costs and act as an insurance against an increase in the price of bank wholesale funding. In doing so, it should help financial institutions in passing on lower rates to their customers. Also the BoE will start to buy corporate bonds (total size GBP 10 bn) which should help to contain credit spreads.

• The 60 bn addition to the sovereign QE program is once again a lump sum package which is probably less effective than the open-ended QE programs implemented by the Fed until 2014 and the ECB currently. These latter programs explicitly tie the continuation of QE to the attainment of the central bank’s objectives.

• We expect more easing in the  next few months where the emphasis will once again be  on mitigating the negative effect for financial sector profits. In this respect one could think of a further rate cut (but less than 25 bps), more private sector asset purchases and possibly a more open ended QE programme." 

by Willem Verhagen, NN Investment Partner Senior Economist