The Bank of England has decided to cut interest rates by 15 basis points to 0.1%, and will increase asset holdings by £200 billion following an extraordinary meeting. The measures come after the Treasury announced a Corporate Financing Facility to provide funding to non-financial businesses.
Next week’s BoE meeting is likely to feature some uncomfortable consideration of potential future moves. Given the BoE’s opposition to cutting rates into negative territory, we are now at the limit of conventional policy options. If further monetary easing is necessary, QE expansion and further liquidity operations are the likely options. In the worst case scenario where the crisis escalates and these options are also exhausted, the next frontier for policy experimentation would be direct financing of fiscal stimulus – an extreme option that would have been unthinkable even months ago.
What the BoE is trying to do here is prevent the social and economic crisis triggered by coronavirus turning into a financial crisis. The brief statement accompanying the decision made it clear that it was driven by recent developments in UK gilt markets, which like other global sovereign debt markets have seen long-dated yields rise rapidly in recent days amid high volatility and poor liquidity.
The resumption of QE, which will be predominantly targeted at government debt, seeks to address this. Other indicators of financial distress, such as LIBOR-OIS spreads, continue to indicate extreme stress in financial markets, as does the global freefall in equities and rampant US dollar strength.
Sterling is rallying today after reaching its lowest point against the US dollar since 1985, although with broad moves in risk appetite and dollar demand dictating the terms for currency markets globally, this reprieve may prove feeling. If sterling does weaken again, the MPC is likely to have bigger fish to fry and another bout of weakness would likely to be acceptable for now. What policy is seeking to do is stabilise domestic sovereign markets and get liquidity to the real economy.
Note the eur has not rallied against USD and so the move on GBPEUR is quite pronounced.
Author: Ranko Berich, Head of Market Analysis at Monex Europe.