The outlook for the UK economy has deteriorated markedly but it was always going to take a little time for the enormity of the UK’s situation to sink in. The Bank of England had signalled they were willing to provide support and had been under increasing pressure from the market to cut interest rates and provide additional monetary stimulus.
The interest rate decision arguably marks the start of Carney’s version of Draghi’s ‘whatever it takes’. The key question facing investors from here is whether it will work, and if not, what other tools the Bank of England has at its disposal.
Will it work?
The theory of low rates is either that it gets the currency down and helps the economy, or it encourages people to borrow and helps GDP. The problem with the former, while in the UK it has worked to some degree, globally it’s a zero sum game. Not everyone can get the currency down. Regarding the latter, encouraging people to borrow when global debt to GDP is already at an all-time high is unlikely to gain much traction.
If someone is coming up to retirement in the next 5-10 years, with interest rates having come down to such a low level, they are going to need a much bigger capital amount to provide the same income. There is a real concern that as rates come down and down, people just say…”I need to save more” and to some degree low rates could have the opposite effect to that intended.
The corporate bond buying will account for around 10% of the outstanding eligible market. Crucially they have said the corporate bond purchases will be over 18 months, as opposed to the gilt purchases over 6 months, which is a recognition of the impact this will have on liquidity.
While this is not on the same scale as the ECB’s corporate bond buying, we think it will encourage the sterling credit markets to open for business and we should see a pick-up in issuance from today’s subdued levels. The Term Funding Scheme, designed to ensure the banks keep lending, should help to somewhat mitigate the impact on their net interest margins from the interest rate cut.
What else could the Bank of England do?
The Bank of England clearly delivered more than expected based on their significantly reduced growth outlook and potential for easing on all fronts. While the Bank of England might look like it is running out of room to manoeuvre, the Bank of Japan and European Central Bank have shown this year that anything is possible on the policy front.
Will we see negative rates in the UK? It’s unlikely at this stage, but entirely possible in our view. The major question mark hangs over whether negative rates are actually working as a strategy. There is also the potential for more aggressive quantitative easing further down the line, which can of course take many different forms.
However, in the event that monetary stimulus fails, a better option to stimulate the economy could be for the Bank of England to embark on a fiscal stimulus package. Though it is a little too early to be talking about helicopter money and the like.
Recent events, including the interest rate decision, have served to reinforce our base case of slow growth, low inflation and high systemic risk. We plan to continue our long-held focus on high conviction credits, with a bias to non-cyclical areas, secured asset-backed bonds, and a good liquidity buffer for ballast in an ever more uncertain and volatile market.
We fully expect the Bank of England to remain accommodative and the potential for further interest rate cuts and additional quantitative easing remains a major positive for fixed income sentiment.