UK central bank cuts rates, ups bond buying

The Bank of England — the UK’s central bank — said it cut interest rates from 0.5% to a record low of 0.25% and introduced a package of measures designed to provide additional monetary stimulus.

This package includes the purchase of up to £10 billion of UK corporate bonds and an expansion of the asset purchase scheme for UK government bonds of £60 billion, taking the total stock of those asset purchases to £435 billion.

“Following the United Kingdom’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short to medium term has weakened markedly,” said the central bank.

“In the real economy, although the weaker medium-term outlook for activity largely reflects a downward revision to the economy’s supply capacity, near-term weakness in demand is likely to open up a margin of spare capacity, including an eventual rise in unemployment.

“Consistent with this, recent surveys of business activity, confidence and optimism suggest that the United Kingdom is likely to see little growth in GDP in the second half of this year.”

The bank said that given the extent of the likely weakness in demand relative to supply, the Monetary Policy Committee (MPC) judged it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation.

It said the cut in rates would lower borrowing costs for households and businesses.

But it added: “However, as interest rates are close to zero, it is likely to be difficult for some banks and building societies to reduce deposit rates much further, which in turn might limit their ability to cut their lending rates.”

In order to mitigate this, the MPC is launching a Term Funding Scheme (TFS) that will provide funding for banks at interest rates close to Bank Rate.

“This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions,” said the central bank.

“In addition, the TFS provides participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.”

The central bank said the expansion of its asset purchase programme for UK government bonds “will impart monetary stimulus by lowering the yields on securities that are used to determine the cost of borrowing for households and businesses.”

“It is also likely to trigger portfolio rebalancing into riskier assets by current holders of government bonds, further enhancing the supply of credit to the broader economy.”

The bank said all members of the MPC agreed that policy stimulus was warranted at this time, “and that Bank Rate should be reduced to 0.25% and be supported by a TFS.”

Eight members of the committee supported the introduction of a corporate bond scheme, and six members supported further purchases of UK government bonds.