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We’ve cut interest rates, but what happens next? We’ve cut interest rates, but what happens next?
(14 days later)
The Bank of England’s Monetary Policy Committee (MPC) did the right thing last week by adding stimulus to the UK economy. It made it clear that the reason was the vote for Brexit. “The committee’s prior belief had been that this outcome could lead to a materially lower path for growth,” it explained. “The early indications had been broadly consistent with this assessment, and this had been reflected in the August inflation report projections … The referendum outcome had a pronounced effect on the domestic outlook.”The Bank of England’s Monetary Policy Committee (MPC) did the right thing last week by adding stimulus to the UK economy. It made it clear that the reason was the vote for Brexit. “The committee’s prior belief had been that this outcome could lead to a materially lower path for growth,” it explained. “The early indications had been broadly consistent with this assessment, and this had been reflected in the August inflation report projections … The referendum outcome had a pronounced effect on the domestic outlook.”
Related: Bank of England's stimulus package has bought the chancellor some time
Interest rates were cut from 0.5% to 0.25%, with more cuts probably coming. They may yet have to go negative, even though the Bank’s governor, Mark Carney, isn’t keen. Over the past year or so I was expecting the next move to be a cut rather than a rate rise, and so it has turned out. Interestingly, since the last time rates were cut in March 2009 there have been 41 votes for rate hikes and not a single one for a cut. It is now obvious a rate rise at any point over the past seven years would have been disastrous. Output in construction and manufacturing, for example, is still well below pre-2008 levels, so the UK economy remains highly vulnerable to an economic shock. Same old, same old.Interest rates were cut from 0.5% to 0.25%, with more cuts probably coming. They may yet have to go negative, even though the Bank’s governor, Mark Carney, isn’t keen. Over the past year or so I was expecting the next move to be a cut rather than a rate rise, and so it has turned out. Interestingly, since the last time rates were cut in March 2009 there have been 41 votes for rate hikes and not a single one for a cut. It is now obvious a rate rise at any point over the past seven years would have been disastrous. Output in construction and manufacturing, for example, is still well below pre-2008 levels, so the UK economy remains highly vulnerable to an economic shock. Same old, same old.
Alongside a cut in the price of money, the MPC also announced an increase in the quantity of money via a new programme of asset purchases covering £60bn of government bonds and £10bn of corporate bonds. The package also included £100bn of new funding to banks to help them pass on the base rate cut to households and businesses. So far, so good.Alongside a cut in the price of money, the MPC also announced an increase in the quantity of money via a new programme of asset purchases covering £60bn of government bonds and £10bn of corporate bonds. The package also included £100bn of new funding to banks to help them pass on the base rate cut to households and businesses. So far, so good.
Two purposes of quantitative easing (QE) that few seem to understand are to weaken the currency and increase asset prices. When a giant buyer enters the financial markets, that pushes up a lot of other prices in the City. When I joined the MPC in July 2006, the pound was worth over $2. When I left in June 2009, with QE under way, the exchange rate had dropped to $1.50. The pound has dropped recently from a high this year of $1.57 to $1.30 and is headed lower.Two purposes of quantitative easing (QE) that few seem to understand are to weaken the currency and increase asset prices. When a giant buyer enters the financial markets, that pushes up a lot of other prices in the City. When I joined the MPC in July 2006, the pound was worth over $2. When I left in June 2009, with QE under way, the exchange rate had dropped to $1.50. The pound has dropped recently from a high this year of $1.57 to $1.30 and is headed lower.
The experience of 2009 is that once QE is announced, you should buy shares. Having peaked at 11,666 at the end of October 2007, the FTSE 250 was down to 6,541 at the beginning of March 2009, when QE was first announced. It was back up at 9,000 by September. At the time of writing, the FTSE 250 had reached 17,599 – up from 16,977 at the close on 3 August, the day before the QE announcement, and likely to be pushed higher by the Bank of England. QE the first time around was also good for gold prices. This is happening again.The experience of 2009 is that once QE is announced, you should buy shares. Having peaked at 11,666 at the end of October 2007, the FTSE 250 was down to 6,541 at the beginning of March 2009, when QE was first announced. It was back up at 9,000 by September. At the time of writing, the FTSE 250 had reached 17,599 – up from 16,977 at the close on 3 August, the day before the QE announcement, and likely to be pushed higher by the Bank of England. QE the first time around was also good for gold prices. This is happening again.
The slowing of the economy is not because economists like me talked it down. It is the lack of a post-Brexit planThe slowing of the economy is not because economists like me talked it down. It is the lack of a post-Brexit plan
My expectation is that the economic data will increasingly resemble what we saw in 2008, particularly with further dramatic falls in business and consumer sentiment. It is hard to know where the economic floor is. The likelihood is we will start to see falls in housing market activity, alongside house prices, and then in real activity. The labour market is likely to slow – which means unemployment is likely to rise, employment will fall, underemployment will rise and wage growth will slow again – but this will take a few months to appear in the data. This means the MPC will have to add more stimulus, pushing up share and gold prices further.My expectation is that the economic data will increasingly resemble what we saw in 2008, particularly with further dramatic falls in business and consumer sentiment. It is hard to know where the economic floor is. The likelihood is we will start to see falls in housing market activity, alongside house prices, and then in real activity. The labour market is likely to slow – which means unemployment is likely to rise, employment will fall, underemployment will rise and wage growth will slow again – but this will take a few months to appear in the data. This means the MPC will have to add more stimulus, pushing up share and gold prices further.
It may well take a year or so to find out the true path of GDP growth and if or when the UK enters recession – ie, experiences two consecutive quarters of negative growth. We didn’t know officially until June 2009 that the UK had entered recession in April 2008, when the ONS confirmed that both the second- and third-quarter growth were negative. It takes time for data to be collected.It may well take a year or so to find out the true path of GDP growth and if or when the UK enters recession – ie, experiences two consecutive quarters of negative growth. We didn’t know officially until June 2009 that the UK had entered recession in April 2008, when the ONS confirmed that both the second- and third-quarter growth were negative. It takes time for data to be collected.
The UK economy is not booming, as claimed by several commentators and newspapers. The slowing of the economy is not because the governor of the Bank of England, or economists like me, talked the economy down. It is the lack of a post-Brexit plan and the rise in uncertainty that have caused the UK economy to nosedive. This uncertainty will not be resolved for several years. The good news is you should be able to make money by buying shares and gold. The bad news is that this will widen inequality further, as it does nothing to help the poor, the young and ordinary strugglers who don’t have assets. Over to you, Chancellor Hammond.The UK economy is not booming, as claimed by several commentators and newspapers. The slowing of the economy is not because the governor of the Bank of England, or economists like me, talked the economy down. It is the lack of a post-Brexit plan and the rise in uncertainty that have caused the UK economy to nosedive. This uncertainty will not be resolved for several years. The good news is you should be able to make money by buying shares and gold. The bad news is that this will widen inequality further, as it does nothing to help the poor, the young and ordinary strugglers who don’t have assets. Over to you, Chancellor Hammond.