The Bank of England has cut its official interest rate by 25bps to 0.25%, a historic 322 year low. Markets had already priced in the reduction as well as an increase in the asset purchase programme but what was actually delivered by BoE chief Mark Carney was well in excess of expectations. What’s more, the statement accompanying the decision indicated “a majority of members expect to support a further cut in Bank Rate to its effective lower bound at one of the MPC’s forthcoming meetings during the course of the year. The MPC currently judges this bound to be close to, but a little above, zero.”
Markets had expected the Bank to purchase another £50+ billion ($80 billion) of UK government bonds but instead the UK central bank announced a £60 billion programme which will take the total stock of gilts owned by the BoE to £435bn, corporate bond purchases worth £10 billion over 18 months and a “term funding scheme” (TFS) which will provide finance to banks and buildings societies at close to the Bank Rate (ed: akin to our official cash rate). In response, UK 2 year bond yields fell 8bps to 0.12%, the yield on 10 year bonds fell 16bps to 0.64% and the pound fell against other major currencies.
NAB’s David de Garis said the combination of the rate cut, the bond purchase programme and the TFS were tantamount to using almost everything at the BoE’s disposal. “While the moves were not totally unexpected, the concerted dual move from the BoE – as close as we could have expected to an “all guns blazing” approach or in the words of BoE Chief Economist Andy Haldane, a “muscular” approach.”
The BoE’s rationale behind the introduction of the TFS is to provide finance at close to the Bank Rate to institutions which are likely to be reluctant to reduce deposit rates further as official rates push towards zero. The TFS will provide financing to these institutions as an alternative to deposit financing and thus allow banks to reduce lending rates without cutting margins. “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.” As well as the carrot of cheap financing, there is a stick. Fees for using the TFS will rise if an institution’s net lending falls so the message from the BoE is to go forth and lend.