UK central bank tries to soften Brexit shock on economy

AP News
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Posted: Aug 04, 2016 1:24 PM
UK central bank tries to soften Brexit shock on economy

LONDON (AP) — Britain's central bank launched a range of stimulus measures Thursday meant to jolt confidence back into an economy shocked by the vote to leave the European Union. Analysts, however, say they may not be enough to halt a slide toward recession.

In a multipronged approach intended to grease the gears of the economy by making borrowing easier and cheaper, the Bank of England cut its key rate to 0.25 percent from a previous record low of 0.5 percent.

It also agreed to pump an additional 60 billion pounds ($79 billion) of new money into the economy through the purchase of government bonds. It furthermore said it will buy up to 10 billion pounds of corporate bonds to make it easier for companies to borrow, and announced a program of cheap loans for banks to make sure they can lend to people and businesses at low rates.

"This is the appropriate response to the economic conditions we find ourselves in," the Bank of England's governor, Mark Carney, told a news conference.

The measures were somewhat bolder than investors had expected, pushing stocks up and the pound down. Experts say they will help shore up confidence at a time of uncertainty by making borrowing marginally cheaper and showing that authorities are taking action. Since the vote's outcome, business and consumer activity in Britain has dropped at the fastest pace since the depths of the financial crisis in 2008, according to surveys.

But they are unlikely to address the economy's fundamental concerns.

While cheaper money will help households and companies, the cost of loans is already very low and is not their primary concern right now, economists say. Businesses in particular are worried about whether to make investments or hire in Britain without knowing what the country's trade relationship with the EU will be. That could take years.

To reflect the grim reality, the Bank of England cuts its economic forecasts by the most in almost two decades, particularly for the period after 2016. While it still predicts 2 percent growth this year thanks to strong growth before the vote, it slashed its forecast for next year to just 0.8 percent from its May estimate of 2.3 percent. That suggests the economy could fall into — or close to — recession, defined as two consecutive quarters of economic contraction.

"We took these steps because the economic outlook has changed markedly" since the referendum, Carney said in a statement. "By acting early and comprehensively, the (Bank of England) can reduce uncertainty, bolster confidence, blunt the slowdown, and support the necessary adjustments in the U.K. economy."

And there may be more in the coming months. All of the measures have scope for further action, including another cut to interest rates "close to, but a little above, zero" if incoming economic data proves broadly consistent with the Bank of England's new forecasts. Carney insisted that subzero interest rates were not being considered.

The value of the British pound fell sharply on the announcement of the measures, as lower rates tend to weigh on a currency. It was down 1.5 percent at $1.3126 by late afternoon in London, while stock markets rose, as the weaker currency will help many of the country's multinationals and exporters earn more money abroad.

One of the main concerns for the U.K. economy is that the immediate drop in confidence caused by the vote could become ingrained, with employers delaying expansion and hiring, and consumers putting off purchases of big-ticket items such as cars and appliances.

Now that the central bank has acted, analysts say, the government also needs to step in by providing clarity on Britain's future relations with the EU and by encouraging growth with government spending and tax incentives.

Lucy O'Carroll, chief economist at Aberdeen Asset Management, described Carney as a "first responder" to the shock of Brexit.

She said Carney had through his comments signaled to the new Treasury chief, Philip Hammond, that the government needs to come up with a plan to make the economy more competitive and invest in infrastructure.

In a nutshell: "Over to you, Mr. Hammond," she said.

Hammond hinted action was possible, saying in a letter to Carney on Thursday that he was "prepared to take any necessary steps to support the economy and promote confidence."

But this will hardly be straightforward. Carney had to pointedly warn banks they had "no excuse" not to pass on the cut in interest rates to consumers. He also acknowledged savers would be hurt by the perennially low rates.

Even so, Carney suggested the actions were needed to face the "new reality" of Brexit.

The bank forecast that Britain would avoid recession but Carney warned of a significant slowdown, unemployment rising to 5.5 percent from 5 percent and falling house prices over the next year. It also predicts inflation will rise past the 2 percent target within three years to around 2.4 percent in 2018 as the weaker pound makes it more expensive to import goods and services.

Ben Brettell, the senior economist at Hargreaves Lansdown said that central bank had little choice but to do something. "Whether these measures are appropriate, only time will tell."