The Bank of England’s Governor Mark Carney has hinted that the UK’s decision to withdraw from the EU could lead to cuts to the Bank base rate.
Speaking at the Bank headquarters in London, Mr Carney predicted that “some monetary policy easing” may be required in the summer. “The result of the referendum is clear,” he told business leaders. “Its full implications for the economy are not.”
Mr Carney spoke positively about the UK’s ability to adjust. But he observed that the decision to exit the Union will mean a redefinition of the country’s relationship with the rest of the trading world. Uncertainty as to the nature of the changes will affect the UK’s economic prospects.
“The question is not whether the UK will adjust,” he remarked, “but how quickly and how well.”
Market reactions: shares rise while the pound falls
The governor delivered his speech on Thursday 30 June, one week after the referendum that saw the UK vote 52% to 48% to leave the European Union.
Following his hints at further economic stimulus, the pound fell against the dollar to $1.33. But UK markets rallied, with the FTSE 100 closing 2.27% higher. The more UK-focused FTSE 250 closed 1.68% higher, but is still far off its pre-referendum level.
US markets also improved, with Wall Street seeing its third day of consecutive growth.
The Bank will clarify its position next month
Mr Carney stressed that he was not speaking for the other independent members of the Monetary Policy Committee (MPC), which convenes each month to set the Bank of England Base Rate.
The MPC will next meet on 14 July to make an initial assessment of the economic situation. It will then publish a full assessment and forecast in August, when its members will also discuss “the range of instruments at [their] disposal”.
This includes further reducing the Bank of England base rate, which has been at a historical low of 0.5% since early 2009. It also includes quantitative easing, a process whereby central banks purchase financial assets from commercial banks, increasing the assets’ prices and boosting the flow of money in the economy.
Though market interest rates are not tied to the base rate, it does have a strong influence on them. Thus, a cut in the base rate would mean cheaper finance for mortgage borrowers.
But Mr Carney is aware of the risks of cutting rates too far.
“As we have seen elsewhere, if interest rates are too low (or negative), the hit to bank profitability could perversely reduce credit availability or even increase its overall price.”
This policy stance represents a dramatic shift for the Bank. In its May Inflation Report, the MPC predicted that domestic cost pressures would push inflation to its target of 2% by mid-2018, and that interest rates would need to rise to ensure this remained sustainable.
It did note, however, that this was based on the assumption of continued EU membership. Last week’s dramatic turn of events may mean that finance costs continue to fall for some time to come.