UK central bank to help economy through Brexit with stimulus

With the British economy in its deepest trouble since the global financial crisis in the wake of the vote to leave the European Union, the Bank of England is expected to unveil Thursday stimulus measures including a rate cut and, possibly, the creation of billions in new money.

Early indicators since the June 23 vote suggest that the economy is contracting at its sharpest rate since 2009. Manufacturing, services and consumer spending are falling, the pound is down 10 percent and questions linger over what trade relations the country will have with the rest of the EU in coming years.

As a result, the Bank of England is expected to cut its key interest rate from a record-low 0.5 percent on Thursday, diverging from policymakers at the U.S. Federal Reserve who in December raised their benchmark for the first time in seven years. The bank may also expand its stimulus program called quantitative easing under which it buys government bonds from banks with newly created money, effectively pumping extra money into the economy.

“The Bank of England should throw the kitchen sink at the problem,” wrote Robert Wood, an economist at Bank of America/Merrill Lynch. “The worst thing that could happen now is the stimulus does not work, so better to do too much.”

The Bank of America Merrill Lynch analysts forecast a 0.25 percentage point rate cut, an additional 50 billion pounds ($67 billion) of bond-buying and other efforts to stimulate lending.

The expectations of such action grew after a gauge of business activity published last week and closely watched by investors and policymakers fell in July to its lowest since early 2009. The survey of 1,200 company executives covers manufacturing and services and showed a broad-based decline in production, orders and hiring intentions.

Another study released last month raised concern that the impact of leaving the EU may be felt for 10 years or more — longer than previously expected. Some 71 percent of leading academic economists surveyed by the University of Chicago said inflation-adjusted incomes in the U.K. will likely be lower a decade from now than they are today because of the British EU exit, or Brexit.

“A post-Brexit agreement between the U.K. and the EU is likely to involve trade barriers,” said Oliver Hart, a British-born economist at Harvard University. “This will reduce gains from trade. The U.K. will suffer.”

One of the main concerns is that the immediate drop in confidence caused by the vote could become ingrained, with employers delaying expansion — and hiring — and consumers putting off purchases of big-ticket items such as cars and appliances.

Bank of England Governor Mark Carney foreshadowed a response by the bank’s Monetary Policy Committee in a June 30 speech.

“In my view, and I am not pre-judging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer,” Carney said. He noted that some of the risks to the economy predicted before the referendum are taking hold.

Even though the potential rate cut is small, it may be seen as another confidence-building move to ease worries in the markets and among the general public about credit drying up. Some experts say there is only so much the central bank can do to help the economy — that even with lower interest rates, businesses and households will remain worried about the future so long as the Brexit talks with EU drag on.

With that uncertainty lingering, Britain is possibly heading toward recession, defined as two consecutive quarters of economic contraction.

The National Institute of Economic and Social Research estimated there is a 50-50 chance of recession over the next 18 months. The influential think tank said growth would hit 1.7 percent overall this year with a decline of 0.2 percent in the third quarter and risk of “further deterioration.”

A few economists think the central bank will wait for more data before acting, as the surveys that have been published so far are reacting to the first weeks of shock in the wake of the vote, when uncertainty was exacerbated by political chaos in the country’s main parties.

UniCredit economist Daniel Vernazza argues that’s not a risk worth taking.

“Given the evidence of a significant shock to confidence, subdued current and expected inflation, and the lags with which monetary policy works, the risks of not easing policy . greatly exceed the risks of stimulating too much,” said Vernazza. “Therefore, on Thursday we expect the Bank of England to act pre-emptively and announce a package of easing measures.”

Joshua Boak contributed to this story

[Source: CNBC]