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Economy

Bank of England cuts rate for 1st time in over 7 years to 0.25%

Updated : August 04, 2016 11:40 PM IST

The Bank of England has cut rates for the first time in over seven years, slashed growth forecasts and launched a new monetary policy weapon in the battle to stop a post-Brexit slump in the UK.

Mark Carney, the governor of the Bank of England, pledged that the bank would "stand ready to act in exceptional circumstances" as he made one of the most dramatic announcements of his tenure.

The central bank has made its biggest quarterly downgrade of growth forecasts, reducing expectations for 2017 growth from 2.3 percent to 0.8 percent, citing "substantial uncertainty" after the referendum on the UK's membership of the European Union (EU) in June. The bank has made these forecasts since 1992.

Its rate-setting committee cut interest rates for the first time in nearly seven and a half years, from 0.5 percent to 0.25 percent, and signaled a further rate cut before the end of the year. This is likely to be "close to but a little above zero", according to the committee's minutes.

Sterling fell sharply against the dollar after the announcement and hit 1.3140 at around 12:30 p.m. London time. British gilt yields also hit record lows.

Negative interest rates, which have been employed by their counterparts elsewhere in Europe, are increasingly being mentioned as a possible policy option for the UK.

While a rate cut was widely expected and the QE is slightly larger than anticipated, Christopher Palmer of Benson Avenue Capital in an interview to CNBC-TV18 says questions remain on whether these will have any beneficial impact on the economy given that many economic participants, businesses and households are still trying to figure out what Brexit is really going to mean for them. 

During the fallout from the UK's vote to leave the EU in June, there have been concerns about how much the bank can do to halt a slowdown, given that it has already gone through close to a decade of extraordinary monetary policy measures.

In an effort to stave off some of the potentially worse impacts of very low or negative interest rates, Carney announced a new Term Funding Scheme worth up to 100 billion pounds (USD 132 billion) and the purchase of up to £10 billion in UK corporate bonds.

A 60 billion pound hike in the bank's government bond-buying program, known as quantitative easing, to £435 billion was also announced.

The corporate bond-buying program is expected to be limited to firms making a material contribution to the UK economy.

The bank's outlook for the post-referendum economy was notably gloomier, with predictions for unemployment to rise to 5.4 percent in the third quarter of 2017, higher than the 4.9 percent previously forecast, "lower real incomes in the UK", and a "little" decline in house prices. Inflation is also now expected to rise faster than previously thought, and the bank forecast it would rise above its 2 percent target in the first quarter of 2018.

An immediate slowdown in GDP growth in the third quarter to 0.1 percent was forecast by the Bank, after a series of data points suggested that economic activity has dropped off and uncertainty over the future among businesses had grown since the referendum. The UK is expected to avoid a recession, according to the Bank projections.

The weakness in sterling, which is now down 9 percent against a basket of currencies since the June vote, may help exports as well as raising the price of imports for UK consumers.

Palmer notes for some households in UK lower interest rates will free up cash as mortgage rates drop. However, given the size of the cuts, GDP forecast and the low interest rate environment, he wonders if it heralds a caution on part of BoE and if that caution will cause people to gain more confidence or lose it.

"I think you can take the moves in the currency - the immediate moves as a sign of whether or not people have more or less confidence in these measures," Palmer concludes.

Below is the transcript of Christopher Palmer's interview to CNBC-TV18's Latha Venkatesh and Surabhi Upadhyay.

Latha: Is this on expected lines or was the quantitative easing (QE) more than what the market expected?

A: I believe that the interest rate cut was widely expected although there was a healthy debate about whether the cut itself would have any benefits for economy. The stimulus in the way of the QE is slightly larger than was expected by the markets. However then the same questions are hanging over both the cut and the QE, which is will it have any beneficial impact on the economy given that that many economic participants, businesses and households are still trying to figure out what Brexit is really going to mean for them.

Surabhi: The Bank of England (BoE) is promising not just this 0.25 percent rate level but they might go down to zero, what does it mean for risk assets? We have seen the pound drop. Today as we speak we are seeing equities move higher, what does it mean for these markets in the slightly more medium term?

A: I think these moves to lower interest rates as we have seen in other countries particularly in Japan as central bank policy moves towards the outskirts of accepted theories, we are going to see more volatility in currencies and in long dated assets. For some households in UK these lower interest rates are going to free up some cash because many people will see their mortgage rates drop. However the basic problem is, given the size of the cuts and the GDP forecast and the already very low interest rate environment, does this herald a caution on the part of the Bank of England and is that caution likely to cause people to have more confidence or less confidence. I think you can take the moves in the currency - the immediate moves as a sign of whether or not people have more or less confidence in these measures.

(With inputs from CNBC-TV18)

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