M&G about today's interest rate decision

Today’s decision by the Bank of England Monetary Policy Committee (MPC) came as a surprise to the market, which was pricing in an 83% chance of a rate cut to 0.25%. The decision to remain on hold this month was likely driven by the MPC's desire to see some early economic data feed through after the referendum result. In our view, the MPC is likely to cut the Bank Rate in August alongside the release of its quarterly Inflation Report, which will include revised forecasts for UK growth and inflation, enabling the BoE to use this information to fully communicate to the market why it has decided to act.

Anthony Doyle

As a result of the economic uncertainty caused by the UK’s decision to leave the EU, we anticipate a contraction in business investment and household consumption. The UK labour market will also be adversely impacted and we expect the unemployment rate to rise as the economy slows and potentially enters into recession. As a result, we expect the MPC to ease monetary policy in August as part of a wider package of measures aimed at shoring up economic growth and support financial stability (such as lowering UK bank capital requirements announced on July 5 and additional macro prudential measures). This time around, the BoE might also include corporate bond purchases within a wider quantitative easing programme.

Going forward, the BoE faces a huge policy challenge. If the MPC acts in August, it would be highly unusual for an inflation targeting central bank to be cutting rates in the face of higher inflation. We expect the pound to come under further pressure in the months ahead and expect that the MPC will continue to use monetary policy to support economic growth rather than target inflation. As a result, inflation is likely to rise and could breach the BoE’s inflation target of 2.0% in 2017. The BoE did a good job of retaining its credibility after the financial crisis in a similar stagflationary environment in 2010-11 but it remains to be seen whether the market will view the rise in inflation as temporary as it has done previously.

Institutions such as the OECD and IMF have argued that now is a good time for the UK Government to step away from its fiscal austerity ambitions, statement with which new Chancellor Hammond seems to agree. The Government has the ability to borrow cheaply and at long maturities. It could use the proceeds from debt raising to stimulate the economy through spending on public investment projects. Quality infrastructure projects could help support future growth, boost competitiveness, increase employment, and deliver real benefits to the economy both immediately and over time. An announcement that the UK government is loosening the fiscal reigns would be more than welcomed by BoE Governor Mark Carney who recently stated ‘One uncomfortable truth is that there are limits to what the Bank of England can do.’