The Bank of England’s Monetary Policy Committee (MPC) voted to cut benchmark interest rates to a new record low of 0.25% last week. This, however, formed only part of a broad set of measures aimed at preventing the economy from suffering a post-Brexit slump. The new stimulus package also includes £70bn of bond purchases and the introduction of a Term Funding Scheme for helping banks to pass on the rate cut to consumers.
As per previous rounds of quantitative easing, the central bank plans to purchase an additional £60bn of gilts (UK government bonds). This is designed to help reduce the longer term cost of borrowing and encourage companies to invest, stimulate growth and support employment. In contrast to previous packages, the central bank plans to purchase corporate bonds with the remaining £10bn, thereby lowering companies’ cost of borrowing and allowing them to fund further investments.
Concurrently, the new Term Funding Scheme will provide as much as £100bn of new funding to banks at interest rates close to the new 0.25% base rate, thus helping and encouraging them to pass on the lower interest rates to households and businesses. Importantly, the scheme will charge a penalty rate if the banks do not lend.
Looking at the implications for investors, the additional monetary easing has initially caused sterling to slump back to its post Brexit lows against the dollar. As one might expect, the announcement of additional bond purchases has forced prices up and yields down. Incredibly, gilts with a duration of 10 years presently yield a meagre 0.7% - a starting point from which long term investors can hardly expect a good return. The UK stock market has also reacted positively – not least because a weak pound is good news for UK-based international companies. Looking forward, it will be interesting to see whether the new Chancellor, Philip Hammond, initiates complementary fiscal action via his Autumn Statement later this year.
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