Buyside Surprised by Bank of England Measures08.05.2016
Investors had been expecting the Bank of England to cut interest rates since the UK vote to leave the European Union, but were surprised by the additional policy measures announced yesterday.
The Bank of England yesterday cut interest rates at a record low of 0.25%, the lowest in the BoE’s 322-year history, in response to the negative impact of the Brexit vote on June 23. In addition the bank said it would create an extra £60bn ($78bn) to buy government bonds, announced a new £100bn Term Funding Scheme to encourage banks to lend cheaply to UK companies and pledged to buy £10bn of corporate debt issued by UK companies.
The Bank of England’s Monetary Policy Committee sets monetary policy to meet the 2% inflation target. The Bank said in a statement “At its meeting ending 3 August 2016, the MPC voted for a package of measures designed to provide additional support to growth and to achieve a sustainable return of inflation to the target.”
Andrew Parry, head of equities at Hermes Investment Management, said in a report that markets largely got what they wanted from the Bank of England’s first interest rate cut in seven years, a £60bn reigniting of quantitative easing and a new £10bn corporate bond buying programme.
Parry added that the surprise in yesterday’s announcement was the Term Funding Scheme.
“With up to £100bn available, it is designed to provide additional lending power to the banking sector without damaging margins,” said Parry. “Potentially, does this amount to a guarantee bank margins? Attention will focus on the detail of this programme when they emerge.”
The Bank of England said it acted due to weak growth since the Brexit vote but Parry argued the preventative medicine is driven more by the need to be seen to be acting than certainty on a poor economic future for the UK.
“After a period of reflection, markets may well return to fretting about the long-term consequences of enduring unconventional monetary policy, and may even start to worry if the UK is set to follow the Eurozone and Japan down the rabbit hole into negative interest rates,” Parry said. “In the end, monetary coercion cannot be the sole basis for long-term economic success.”
Mike Amey, head of sterling portfolio management at Pimco said in a blog that the four policy moves – cutting interest rates, restarting quantitative easing, initiating a corporate bond buying programme and providing financing support to the banking system – constitute a decisive and comprehensive package. He added that the new policy measures should go some way to negating risks from the speed of deterioration in the Purchasing Managers’ Index and other surveys since the Brexit vote.
“This suggests monetary policy will remain highly accommodative for much of the cyclical horizon, keeping the damper on shorter to medium-term UK sovereign yields despite the fact that many are already hitting new lows,” said Amey.
He expects that longer-term gilt yields should be supported by the Bank’s policy moves and the broader economic environment while the pound has the potential to go lower.
Amey continued that the Bank of England’s asset purchase programme will take six months to complete and the corporate bond purchase programme is intended to be completed over an 18-month period.
The Bank said that expansion of the 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 and 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.
In addition purchases of corporate bonds could provide somewhat more stimulus than the same amount of gilt purchases.
“In particular, given that corporate bonds are higher-yielding instruments than government bonds, investors selling corporate debt to the Bank could be more likely to invest the money received in other corporate assets than those selling gilts,” said the Bank of England. “In addition, by increasing demand in secondary markets, purchases by the Bank could reduce liquidity premia; and such purchases could stimulate issuance in sterling corporate bond markets.”
Timothy Graf, head of macro strategy at State Street Global Markets for Europe, Middle East and Africa, said in an email that surprising the market was going to be a tall order, but the Bank of England did just that as it appears more concerned about the prospect of a deep recession than expected.
Graf said: “I am surprised that they decided to implement a number of measures to address the problem at such an early stage, but given the sharp drops we have already seen in the survey data, they likely anticipate more bad news to come.”
Shilen Shah, bond strategist at Investec Wealth & Investment, agreed in an email that the Bank was driven to act by worse data that expected following the Brexit vote.
“The Monetary Policy Committee also indicated further cuts in the base rate are probable over the next few meetings,” Shah said. “Despite the Bank of England expecting inflation to increase above its 2% target in 2017, concerns over the UK’s economic health as indicated by the sharp falls in July’s PMI has spooked the central bank into action.”
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