The Bank of England did not disappoint all those who wanted it to take action to stimulate UK activity. It used several of its monetary tools to seek to boost demand and extend more credit in the economy. It cut the base rate from 0.5% to 0.25%. It introduced up to £100bn of new low-cost borrowing for banks wishing to lend the money on to their customers. It sanctioned a further £60bn of purchases of UK government bonds from newly created money, and a £10bn purchase programme of corporate bonds to lower the costs of company financing. It continued with policies designed to prevent bank balance sheet regulation offsetting the loosening effects of the other measures.
There are those who now say the problem is the Bank has reached the limits of what monetary policy can do. The Bank itself falls over backwards to stress it can do a lot more of the same, including a further interest rate cut, though it does not wish to take rates negative. Perhaps a bigger issue is will it need to do anymore? Just how weak could the UK economy become? What evidence is there that there is a serious threat to growth?
At the same time as taking such strong action the Bank revised its forecasts for the UK economy. Curiously it kept its 2016 forecast at 2% GDP growth, and looked forward to 1.8% growth in 2018. These figures remain good by European and even by advanced world standards generally. It marked down its 2017 forecast more severely, suggesting growth will that year fall to 0.8%. It raised its CPI inflation forecasts to 1.9% in 2017 and 2.4% in 2018, following just 0.8% estimated for 2016. This mainly reflects the fall in sterling, serving to increase import prices. Employment rises by 0.5% in 2016 and is level in 2017 in its estimates, causing unemployment to rise presumably as the workforce continues to expand.
The Bank is understandably cautious about its forecast given the lack of hard data on what has happened since the referendum which looms so large in the Bank’s thinking. The Bank says: “Domestic demand growth is therefore likely to slow materially over the near term, though there is considerable uncertainty over the extent of that slowing.” Yet elsewhere the Bank reports that “timely indicators of consumer spending, such as retail footfall, do not yet point to a material slowing.”
The Bank looks at a few detailed sectors for possible bad news to justify this substantial monetary stimulus. They argue that larger companies will slow their investment plans owing to uncertainty. They anticipate falls in prices and volumes in the property market. However, here they also argue that when it comes to residential property “prices are projected to decline a little over the near term, while the level of transactions remains broadly flat.” The Bank acknowledges that the changes to Stamp Duty and Buy to Let had a substantial distorting effect on the market, bringing forward transactions to beat the April deadline for the tax rises. It suggests there could be falls in commercial property values citing the open-ended funds that have closed themselves to dealings and citing falls in REIT share prices immediately after the referendum vote. The Bank does not look at evidence pointing in the other direction that there are buyers for property and property funds and shares. It would be unusual for commercial property as a whole to decline in value when bond yields and interest rates are falling.
The Bank also argues that shares in certain domestic sectors have fallen despite the general recovery and rise in shares since the June big mark down after the vote. It singles out finance and construction. It is true there has been some decline in construction activity, and UK banks have joined in the general decline of European banking shares as recent stress tests highlighted weaknesses in the sector again.
We think this added stimulus reinforces the case for expecting reasonable growth from the UK economy over the next two years. It suggests share prices can make further progress on the back of ultra-low interest rates and a very elevated bond market. We are less pessimistic than the Bank about 2017 growth. The Bank has made us more nervous about sterling, which remains the most vulnerable part of UK markets for the time being. Too much of a decline in the pound would boost inflation more than is desirable, and hit real incomes, which are beginning to grow nicely.
The above article by John Redwood, Charles Stanley’s Chief Global Strategist, was first published by Charles Stanley on 5th August 2016.