James Bevan: Reflections on an interest rate cut
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James Bevan
Following the Brexit vote, it was reasonable to assume that the value of sterling would fall to whatever level was necessary to ensure that UK investment spending beat pessimists’ forecasts, even if this would most likely entail a consumer recession as rising import prices eroded household purchasing power.
Last week, Bank of England governor Mark Carney decided that sterling needed to be even weaker than the market had already decided by cutting rates despite what is still probably a weakening current account balance position (as a result of the “J Curve Effect”).
Unfortunately, we may suspect that the drop in net interest income that this move implies and the further rise in import prices will make the squeeze on household real incomes worse rather than better.
During 2015, the UK household sector benefited from a slight surplus in its net interest payments and a modest drop in import prices but this year both terms appear set to become “headwinds” for the economy.
Potentially, the drop in yields may encourage more consumer borrowing, although experience elsewhere has suggested that ultra-low rates often erode the supply of credit as the banks face profitability concerns even if they succeed in raising the demand for credit.
Household deficit
Moreover, it is not entirely clear that UK households should be endeavouring to move further into financial deficit at this time – households are, after all, expected to save something, and if the economic outlook is really that uncertain at present, we must wonder how Mr. Carney can justify asking households to undermine their own finances by deficit financing of their spending.
The announcement of new QE certainly surprised us and it seems a little strange that this has occurred given just how low bond yields are. At one level we might hope that Carney’s move in the bond markets represents a precursor to the reversal of Osbourne’s austerity-at-all costs.
But we may suspect that it is more likely that the Bank will simply find that it is providing liquidity to those investors that want to exit gilts at an attractive price.
Indeed, given that UK banks currently own a record £140bn of gilts, the BoE may find that its counterparties are other banks, and this situation would undermine any monetary impact from the QE.
We might also wonder if the BoE’s decision is in practice really just a knee jerk reaction, and perhaps connected to the BoE’s pre-Brexit vote stance.
Ostensibly, the BoE’s move has come in response to the recent string of very poor confidence survey results, although these probably themselves were in essence an emotional reaction to the outcome of the vote.
Evidence
Personally, we might have waited for more hard evidence over the state of the economy but with seemingly every other policymaker blaming Brexit for all manner of ills, Carney probably felt the need to be seen doing something.
What concerns us is that most real world contacts that we have spoken with suggest that while the consumer may indeed have been unsettled, business investment was actually holding up but the BoE’s policy decisions may actually make companies stop and think what it is that the BoE (thinks it) knows that they don’t.
Businesses can become more risk averse when central banks appear to panic – and it is not clear that Carney, through his impact on both consumers and the corporate sector, will have done much to support growth and he may even have detracted from it.
Better, we suspect, would have been to outline a medium term plan for stability rather than rush around pulling levers “in case” the situation was as dire as some predicted it would be following a “leave” vote – and there’s the risk that confidence now falls delivering the very downturn that policy was intended to avert.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
*CCLA is a supporter of Room151
