British Monetary Policy Moves Closer to that of the US
Last week the Bank of England, central bank of the United Kingdom, announced its first major changes in monetary policy since the Brexit vote this past June. The decisions taken by the UK’s Monetary Policy Committee (MPC) reflect a financial and monetary climate very similar to that which prevails in the United States. Most importantly, the Bank of England decided to lower interest rates and engage in open market asset purchases. These decisions are driven by the economic uncertainty and fears created by the Brexit decision and its sociopolitical aftermath. This article analyzes the policy measures taken by the Bank of England and contrasts them with the current monetary policy of the United States.
Monetary Policy Committee
After meeting during the first week of August, the Bank of England decided to react to the economic consequences that have ensued from the decision to leave the European Union. Since the Brexit vote, the British Pound has been trading at an average 10% lower than its pre-June value and this exchange rate is not expected to change in the short to medium-term. A weaker Pound is likely to increase British exports, raise the Consumer Price Index (CPI) inflation rate because of the more expensive imports, and reduce aggregate demand within the British economy. These dynamics will be useful in the short-term because they will exert upwards pressure on the currently below-target inflation rate. Central Banks in western economies have been struggling to meet their target inflation rates of 2.0% because of the low energy prices that have prevailed over the last several years. However, an eventual decrease in aggregate demand, because of the decrease in overall purchasing power, will exert downward pressure on prices as well as inflation over the medium to long-term.
Similarities with the Federal Reserve
The measures taken by the Bank of England’s MPC reflect a preoccupation with the possibility of a major economic slowdown and seek to stimulate aggregate demand. The first measure announced is the reduction of the Bank rate or interest rate from 0.5% to 0.25%. This 25 basis points decrease sets the UK’s Bank rate at a historic low and represents the first interest rate cut since the immediate aftermath to the 2008 financial crisis. This average interest rate of 0.25% is lower than the Federal Funds rate in the United States, which stands at a range between 0.25% and 0.5%. As in the US, the British monetary policy measures expect to increase consumer spending, business investment, and loan refinancing. However, the near-zero interest rate decreases the MPC’s maneuver margin, decreases the yield of traditional financial instruments, and could lead to greater financial uncertainty.
Another policy measure, which is also aimed at increasing monetary supply and consumer spending, is the purchase of ₤60 billion worth of government bonds and ₤10 billion worth of corporate bonds. Similar to the quantitative easing and open market purchases executed by the Federal Reserve since the 2008 economic crisis, the MPC’s decision seeks to increase the money supply as well as the lending capacities of commercial banks. By extending quantitative easing and corporate bond purchases, the Bank of England facilitates the possibility of private sector economic activity. However, the availability of financial resources, such as loans, does not guarantee that private investment will take place.
The monetary policy recently implemented by the Bank of England is aimed at revitalizing the British economy during the years to come. Nevertheless, the success of these policies is not certain and places the United Kingdom in a similar position to that of the United States. Investors and financiers should consider the elements presented above, when deciding how to save, invest, and preserve their capital.
(Read more on how Brexit Creates Uncertainty and Opportunity in Agribusiness)