Bank of England rate cut and QE may turn out to be premature and unnecessary

The Bank of England, as markets expected, has cut interest rates to a new multi-centuries low of 0.25% — its first move for more than seven years. It also announced a bit of extra quantitative easing and a new scheme for encouraging banks to lend more.

The extra bank lending support is little more than an extension/variation of the previous “funding-for-lending” scheme, and might have been worth considering under any circumstances. The rate cut is likely to have relatively little impact other than potentially by weakening the exchange rate a little — if that’s what the Bank wanted.

It is hard to see why further weakening was really necessary given that the effective exchange rate had already fallen 10-15% in the run-up to and immediate aftermath of the Brexit referendum. Rates were at 0.5% for seven years because the Bank regarded 0.5% as effectively zero, anyway. A cut to 0.25% creates extra problems for banks in funding themselves and is likely to be slightly counterproductive rather than helpful. But it’s relatively harmless other than as a somewhat panicky signal that the Bank thinks the economy is going very badly post-referendum.

I’d have held rates and got authorisation for a bit of extra QE, though without actually doing any more yet. The Bank thinks Brexit will mean 2.5% less GDP growth over the next three years, though probably no recession, and that what happens later depends crucially on our subsequent international trading relationships. I said in advance of the referendum a Brexit vote would probably mean 2-3% lower GDP growth in the period around exit, caught up later. So no surprise in the Bank’s numbers, there.

They are still speculative, though. All we really have so far are some survey evidence from July, when reactions to the referendum result and the political turmoil that followed were still pretty raw and confused. We’re told that is consistent with 0.4% contraction in Q3, but we’re only one month into Q3.

It’s perfectly possible that August and September snap back and Q3 turns out only a little slower than the fairly rapid 0.6% growth we got in Q2. It’s all a bit panicky reacting so much to a few weeks’ survey data.

I expect Brexit to imply slower growth, and the Bank has tools such as QE or, perhaps more importantly, delaying the speed at which it raises interest rates (remember: rises were expected by now, only a few months ago) to respond. It’s jumped the gun a little, in my view, but probably fairly harmlessly so at this stage.

These short-term impacts will start to be a lot clearer once we have some vague idea of what Brexit will involve. We don’t even know which year it’s going to be, yet! Keep calm and carry on.

Dr Andrew Lilico is Executive Director and Principal of Europe Economics. He is a Fellow of the Institute of Economic Affairs and Chairman of the IEA/Sunday Times Monetary Policy Committee. As Chief Economist of Policy Exchange from 2009-10 he produced what the BBC has described as the “essential theory” behind the Coalition’s initial deficit reduction strategy.