Quick Thoughts on the BOE
1. The Bank was crystal clear in its reasoning for easing: potential supply is taking a big hit from the fallout from Brexit but in the short to medium term demand is taking a bigger hit. The output gap is widening and there is more spare capacity as demand falls faster than supply. Today’s package is aimed at closing that gap faster. Yes inflation is heading above target, but they are happy to look through that.
2. The package is bigger than expected and the Bank was clear it is happy to go further. Base rate could be cut again and both the QE and corporate bond purchases could be stepped up. As can the term funding for commercial banks.
3. But whilst the Bank is happy with unconventional monetary policy it ruled out what might be termed “extraordinary monetary policy”. Carney explicitly ruled out negative interest rates and almost chuckled at the idea of helicopter money which he called “a flight of fancy”.
4. The MPC wasn’t united on the expansion of unconventional easing either — the vote for a rate cut was 9/0 but for corporate bond purchases was 8/1 and for more QE was 6/3.
5. So whilst the Bank isn’t quite out of ammunition, it is running very low. Ruling out negative rates means there isn’t much conventional cutting to be done, the size of the sterling bond market limits the eventual scaling up of purchases there and the effectiveness of QE when gilt yields are already at historic lows is open to question.
6. The Bank isn’t forecasting a recession as its base case (although would have been forecasting one if it hadn’t been for its easing measures). That is still the big near term uncertainty. They are hoping for a bounce in the PMIs in the coming months and assuming that the initial post referendum falls in survey based data were exaggerated by the shock of Brexit.
7. The element of their forecast which looks most at risk to me is wage growth. They see a moderate slowdown in the pace of wage growth even as unemployment rises by 250,000. But given recent labour market performance in the UK where even large falls in unemployment hasn’t pushed wage growth much higher, I’d be very cautious with this assumption.
8. The basic takeaways today are: the Bank is doing what it can to manage the short run fallout but it can’t do everything and eyes will nowstart to turn to the Treasury to see if it steeps up with a stimulus.