The Bank of England has dropped interest rates by 25 basis points to 0.25 percent, with the outlook for growth in the short to medium term weakening “markedly”.
The decision follows the UK’s vote to leave the EU in June, and comes as a response to the drop in the value of the pound.
In a statement, the Bank of England said: “Recent surveys of business activity, confidence and optimism suggest that the UK is likely to see little growth in GDP in the second half of this year.”
The Bank of England Monetary Policy Committee (MPC) voted unanimously for the drop in interest rates. The committee also passed a package of measures designed to provide additional support to growth, including the purchase of £10 billion in UK corporate bonds, and the expansion of the asset purchase facility for UK government bonds, to the tune of £60 billion.
This measure brings the bank’s total stock of asset purchases to £435 billion, all of which is financed by the issuance of central bank reserves.
According to the central bank, the asset purchase programme for government bonds should lower the yields on securities used to determine the cost of borrowing. It is also intended to encourage current holders of government bonds to rebalance their portfolios into riskier assets, therefore improving the supply of credit to the broader economy.
Similarly, as corporate bonds are higher yielding instruments, the central bank’s purchasing of them means selling investors will be more likely to then invest in other corporate assets.
By increasing demand in secondary markets, the corporate bond purchases should ultimately stimulate issuance in sterling bond markets.
The Bank of England’s statement continued: “The MPC has examined closely the interaction between monetary policy and the financial sector, both with regard to ensuring the effective transmission of monetary policy to households and businesses, and with consideration for the financial stability consequences of its policy actions.”
Commenting on the announcement, Graham Vidler, director of external affairs at the Pensions and Lifetime Savings Association, said the cut in interest rates will give pension funds “cause for concern”, and that the quantitative easing measures will put additional pressure on them.
“While we recognise the need to protect the UK economy, strong consideration needs to be given to the negative impact this will have on the 6,000 private defined benefit pension schemes,” he said.
“As these bonds are higher-yielding instruments they could provide more stimulus than the same amount of gilt purchases, but nonetheless the impact this will have on gilt yields will be an additional burden for many schemes already struggling.”
With regards to the decision to cut interest rates, Darren Bustin, head of derivatives at Royal London Asset Management, said that “monetary policy is running out of steam”.
He said: “The actions of the Bank of England today may not be the most effective tool in driving the UK economy going forward, and a fiscal response may be required to revive the economy if things get worse.”
