With its first policy move in four years and first interest rate move in seven years, the Bank of England’s Monetary Policy Committee has very much embraced the view that if you decide to ease, then be aggressive. When your economy is approaching the zero lower bound on interest rates and intermediate gilt yields are already well below 1%, it makes sense to use what modest monetary scope you have as decisively as you can. Today’s four policy moves – to cut interest rates to 0.25%, restart quantitative easing, initiate a corporate bond buying programme and provide financing support to the banking system – certainly constitute a decisive and comprehensive package. Now the two critical questions are will it work, and what are the investment implications?
Whether it is likely to work is best explained by looking at the BOE’s growth and inflation forecasts, which are very similar to PIMCO’s. UK growth is expected to fall to just above zero for the next twelve months, and then rise back up to 2% by 2018–2019. Headline inflation is expected to rise to 2.5% and fall back slowly to the 2% target thereafter. This represents a relatively benign outlook, and assuming the new Chancellor announces some reversal of the previous plan to further tighten fiscal policy, there looks to be a good chance that these forecasts will be realised. Given the speed of deterioration in the Purchasing Managers’ Index and other surveys released post the Brexit vote, there are clearly risks to the outlook, but the new policy measures should go some way to negating those risks.
Of particular note is that the BOE’s asset purchase programme will take six months to complete and the corporate bond purchase programme is intended to be completed over an 18-month period. This suggests monetary policy will remain highly accommodative for much of the cyclical horizon, keeping the damper on shorter- to medium-term UK sovereign yields despite the fact that many are already hitting new lows. In relative terms, longer-dated (30-year) gilts yielding around 1.5% are becoming more attractive versus shorter maturities, where yields are around 0.1% on the two-year and 0.7% on the 10-year. Meanwhile the British pound has been weak today, but is still at levels above those seen in the last month.
In summary, we expect longer-term gilt yields should be supported by the BOE policy moves and the broader economic environment, whilst the British pound looks to have scope to go lower.