The Bank of England’s reaction towards the vote for Brexit

The “unreliable boyfriend”: That´s the nickname that the City of London has given Mark Carney, the Canadian who has been running the Bank of England since 2013. How did he earn that honour? Several times last year – with the EU-referendum still months and months away, the British economy presented itself in rude health – Carney hinted towards a potential rate rise, only to disappoint investors and analysts by leaving rates at the level they have been since 2009, 0.5 percent. Since then, the City never really trusted the comments that came out of Threadneedle Street.

About six weeks after the historic vote for Brexit, things have changed quite dramatically. As he proved on Thursday, Mark Carney no longer deserves his nickname. Contrary to the past, the head of the BoE met the expectations of the financial community: On Wednesday, the Monetary Policy Committee (MPC), the core decision-making organ of the Central Bank, decided to cut rates to 0.25 percent and to restart Quantitative Easing (QE). In addition to that, the MPC decided to create a new credit facility for banks and house-building societies.

With these measures in place, Governor Carney and the Chancellor of the Exchequer,  Philip Hammond, hope to moderate the negative impact of the EU-referendum on the British economy. Important indicators such as the most recent Purchasing Managers Index (PMI) point towards a drastic slowdown since the end of June. Because of this situation, the BoE has adjusted its forecast for next year: Instead of 2.3 percent as previously forecasted, the central bank only expects meagre growth of around 0.8 percent, the biggest amendment since 1983. After the expected rate cut, it remains to be seen whether the Central Bank will be able to prevent a hard landing. Ultimately, the core problem of the British economy is caused by the uncertainty about the future relationship between the UK and the EU – a problem that monetary policy cannot solve.

According to the report published on Thursday, the BoE expects an increase in inflation, more unemployment and less consumer demand after the vote for Brexit. At 4.9 percent, unemployment is currently at a historic low. However, it is supposed to rise again, to 5.4 percent in 2017 and 5.6 percent in 2018. Because of the expected slump in consumer demand, the MPC has decided to restart QE, a policy measure that hasn´t been used since 2013. Now, the BoE is allowed to buy British government bonds (gilts) of up to 60 billion pounds and, in addition to this, corporate bonds of up to 10 billion pounds. By including corporate bonds, the BoE follows the example of the European Central Bank (ECB) which started buying corporate bonds in early June as part of its QE-program.

The cut in interest rates will most likely reduce the profitability of British banks. Simon-Kucher & Partners, a strategy consultancy, expects operating profits of the 21 largest banks and house-building societies to decline by up to 1.4 billion pounds, now that rates have been reduced to their lowest level for 322 years. In order to prevent a new banking crisis, the MPC introduced a credit program for banks and house-building societies, the so called “Term Funding Scheme” which provides financial institutions with the opportunity to borrow money at rates close to the bank rate. Previous QE-programs included, the balance sheet of the BoE could swell to levels of up to 545 billion pounds thanks to the measures announced on Thursday.

Initially, analysts and markets reacted positively. However, it remains to be seen whether the measures of the BoE deliver the desired results. The underlying problem of the British economy is not access to capital and a lack of funding, but the heightened levels of uncertainty since the British voted for Brexit on the 23rd of June. As long as there is no clarity over the future relationship between the UK and the EU, monetary policy can only do so much to support confidence and investment.

It depends on the outcome of the negotiations between London and Brussels whether the British economy enters a long and severe crisis or whether it recovers relatively quickly and, maybe even more important, only with minor bruises. According to what Theresa May has said, it will take a while until the official start of the negotiations. The Prime Minister intends to wait until early 2017 before she triggers Article 50 of the Lisbon Treaty which will commence the divorce process between the UK and the EU.

Mark Carney is aware of this, as his letter to Chancellor Hammond indicates. “Many of the adjustments needed to move to that new equilibrium (the new relationship between the UK and the EU) are real in nature, and are not the gift of monetary policy makers. Nonetheless, monetary policy can still play a role in smoothing part of this adjustment by appropriately balancing the forces acting to push inflation above the target with those expected to push activity below the economy’s new path for potential output.” Analysts as well as business associations, such as the British Chambers of Commerce (BCC), remain sceptical as to whether the BoE’s actions will produce the desired results. “Lower interest rates may give a helpful boost to market confidence, but have little-long term effect on businesses when rates are already so low”, comments Adam Marshall, acting Director General of the BCC.

Independent of this, Chancellor Hammond seems to be confident regarding the future prospects for the British economy. “The UK economy is fundamentally strong – employment is at a record high, there are almost a million new businesses since 2010 and the budget deficit has been reduced by almost two-thirds as a share of GDP. This is a new chapter for Britain, but we are well-placed to deal with the volatility caused by the vote to leave the EU”, Hammond writes in a letter to the Governor of the Central Bank.

He continues by stating: “I am prepared to take any necessary steps to support the economy and promote confidence. The UK starts from a position of economic strength as we address the challenges and take advantage of the opportunities that will arise as we forge a new relationship with the EU.” Regardless of the slowdown that indicators such as the most recent version of the PMI point out, the BoE has left its growth forecast for 2016 unchanged. In the year of the EU-referendum, the British economy is supposed to grow by 2 percent, the BoE thinks.

After their decision on Wednesday, the members of the MPC will only reconvene in early November. By then, the impact of the vote for Brexit on the state of the economy should be more obvious than it is today. Should there be a further deterioration of sentiment, the MPC might reduce rates further, but not to zero. According to the statement put out by the BoE, the bank rate is supposed to remain a little above zero, potentially avoiding some of the problems that the European counterpart of the BoE, the ECB, finds itself in after the introduction of negative interest rates.

Not only the BoE, but also the Chancellor could be taking further measures soon. He will deliver his first Autumn Statement in November and is expected to announce fiscal stimulus for the ailing economy.

But will Hammond be able to take away some of the uncertainty British firms suffer from? We’ll see.





The saviour of the British economy?

A safe pair of hands. Over and over again, British media outlets have used these words to describe Theresa May, the new Prime Minister. She is said to be stable and reliable, and yes, a bit boring. But maybe that’s exactly what the country needs now, after all the excitement that her predecessor David Cameron provided the UK with.

Similar things are being said about Theresa May’s new chancellor, Philip Hammond. The 60-year old has already held several ministerial posts – he was Foreign and Defence Secretary, among others – and has, contrary to many of his colleagues in the House of Commons, had a “real” job before becoming a Member of Parliament 19 years ago. After his studies at Oxford University, Hammond worked for a company that sells medical appliances, spent some time in South America as a consultant for the World Bank and became a partner at a consultancy firm.

Prior to the British EU-referendum on the 23rd of June, Hammond was part of the Remain-camp. It is expected that he will try to negotiate a deal under which the City of London can maintain its passporting rights into Europe, a crucial factor for London to keep its status as Europe’s leading financial center. At the same time, the Conservative will have to stabilise the British economy and regain trust from international investors. Thanks to its high budget and current account deficit, Britain will continue to rely on foreign funding – even more so, should there be a sharp recession looming.

Philip Hammond has had an eye out for the prestigious role for a while. Already in 2010, when the Conservatives formed a government with the Liberal Democrats, the man with the grey mane uttered his interest for the role as a Chief Secretary in Her Majesty’s Treasury, the second most important job after that of the Minister. However, at that point in time, a Liberal got the chance.

Thus, Hammond started in the Department of Transport before becoming Defence Secretary in 2011 and Foreign Secretary in 2014. A Member of Parliament, Hammond has represented Runnymede and Weybridge since 1997 – a constituency that voted Leave although their MEP supported Britain to remain in the EU.

Philip Hammond will now have to make use of his vast experience in order to reassure international investors that the UK is still a good destination for their money. “We don`t turn our back against the world”, he said after his appointment. Hammond pledged to take “whatever measures” needed to help stabilise the economy and retain Britain as an attractive destination for firms to invest.

It remains to be seen what this means for his tax policies. On Thursday, Hammond declined to comment on the announcements made by his predecessor George Osborne to slash corporation tax to 15 percent. Hammond is known for his support for low taxes. Nevertheless, it is still too early to tell whether Hammond will engage in, as some critics such as Pascal Lamy, the former head of the WTO, have claimed, extensive tax dumping in order to keep companies from leaving the UK after the divorce from the EU.

There is more to watch out for. There are two areas where Hammond could clash with his new boss fairly soon. First, there is fiscal politics. Hammond has a reputation of being a “fiscal hawk”. Nevertheless, he cannot just continue what George Osborne started in 2010 when he embarked on a massive austerity program that still is not finished. Prime Minister May has been very clear in the past days that the government’s first goal should not be – as planned before – to generate a budget surplus by 2020 but to make sure that more people benefit from economic growth and prosperity (assuming, of course, there is still something left to share after Brexit).

We might get a first glance of his fiscal plans when he presents the Autumn Statement in November. Different to what then chancellor George Osborne announced before the referendum, there won’t be an emergency budget. Experts like Kallum Pickering, the UK economist at Berenberg Bank, thus expect some more fiscal loosening in the short run whilst more cuts are being postponed towards the end of the Parliament.

Besides fiscal policy, there is a second topic that holds vast potential for conflict, the so called passport for the City of London. This framework allows banks headquartered in London to sell their products on the continent. Should the City of London lose these rights, several thousand jobs could be moved to Frankfurt, Paris or Dublin. London would subsequently lose some of its attractiveness for international banks. Hammond seems to be all too aware of this. On Tuesday, he stated at the British Bankers Association that the financial industry will be possibly hit the hardest by Brexit. “I know and understand the importance of passporting”, Hammond said.

Theresa May though not only needs to satisfy the banks, but also those 17 million Brexit-voters of which many requested the European Freedom of Labour Movement to be scrapped or at least reduced. Leading EU-politicians such as Jean-Claude Juncker, the President of the European Commission, or Angela Merkel, the German chancellor, have already made clear that there is not too much room for negotiation here. Access to the Single Market and passporting can only be sustained if the four freedoms remain in place. So where will that leave the two safe pairs of hands?