BoE more likely to cut rates - BBH

Research Team at BBH, suggests that the Bank of England is the more likely to cut rates in its forthcoming meet this week.  

Key Quotes

“BOE Governor Carney has already acknowledged that this may be necessary.  The central bank has already canceled the anticipated increase in banks' capital buffers.  The market appears to have discounted a 25 bp base rate cut.  The implied yield of the September short-sterling futures contract has fallen from nearly 60 bp before the referendum to 33 bp at the end of last week, having briefly touched a low point of 28 bp.

Some economists anticipate the Bank of England will bring the base rate down from 50 bp to 10-15 bp over time.  While this is possible, we suspect that at 25 bp, officials would have gotten as much stimulus from lowering the base rate as possible.  Should further stimulus be judged necessary, and we suspect it will, new asset purchases would seem to be a more promising measure than another cut in the price of money.  

To be clear, if a 25 bp rate cut is not delivered at this week's meeting, sterling would likely act positively, at least initially.  It would be seen as a sign of caution.  It would likely signal more emphasis on the new forecasts that are provided with the Quarterly Inflation Report next month.  However, the Bank of England, apparently more than many others, took seriously the risk of Brexit, and what was once a risk forecast, now becomes the base case, more or less.  

It still needs to calibrate its response, but perhaps the most surprising thing that has happened since the referendum is the resilience of the FTSE 250.  We appreciate that the FTSE 100’s stronger performance is a function of its heavy dependence on foreign earnings which are all the more valuable in a weak sterling environment.  The FTSE 250 finished last week at roughly the midpoint of the referendum induced drop.  Parts of the UK economy looked to be softening before the referendum, but economic readings outside of consumer surveys, are not in real time.  

The freezing up of the several property funds is instructive.  Although the problem looks contained, there are still risks of unforeseen contagions.  Also, the interlocking ownership of some of the funds, pose concentration risks that regulators may want to investigate.

One of takeaways from the Great Financial Crisis experience is the most effective policy response comes early and forcefully.  The Bank of England has every reasons to suspect that the Brexit decision will hit an economy that may have already been slowing.  The political firestorm does not help matters.  The BOE can act, or it can react.  We suspect it will act.  This does not preclude the BOE from doing more later.  It can cut rates now and launch QE next month, with the Quarterly Inflation Report.  We envision a modest purchase program (~GBP50 bln) that would be completed in a few months.”