Bank of England slashes 2017 growth forecast, expects stimulus to avert recession

The Bank of England slashed its growth forecasts for 2017 in its quarterly Inflation Report on Thursday, but expects to steer the UK economy away from recession with a cut in interest rates and a package of stimulus measures to reignite growth.

The central bank said the economy is likely to see "little growth" in second half of the year, with GDP growth slumping to just 0.1% in the third and fourth quarters.

Forecasts for next year were hacked down by the most since since the Monetary Policy Committee (MPC) was first formed, anticipating GDP will increase just 0.8% in 2017, down from previous expectations of 2.3%.

A weaker pound, which quickly retreated on the confirmation of the rate cut, is likely to push up CPI through the BoE's 2% inflation target in the near term to 2.4% in two years’ time, the report said, as a result of the stimulus measures.

Unemployment is also seen as rising to 5.6% in two years’ time, up from May's projection of 4.9%.

Alongside cutting the bank rate to 0.25%, as largely expected, the MPC extended quantitative easing (QE) by £60bn to £435bn and plans to undertake £10bn of corporate bond purchases over the next 18 months, with a new 'term funding scheme' (TFS) is designed to encourage bank borrowing, while also signalling that more easing could be on its way soon.

While the cut in the bank rate will reduce borrowing costs for households and businesses, the TFS has been launched as it is "likely to be difficult for some banks and building societies to reduce deposit rates much further, which in turn might limit their ability to cut their lending rates". The TFS, which could be worth up to £100bn, will provide funding for banks at interest rates close to the bank rate.

"This monetary policy action should help reinforce the transmission of the reduction in bank rate to the real economy to ensure that households and firms benefit from the MPC's actions," the Bank said in the report.

"In addition, the TFS provides participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets."

If economic data over coming months proves broadly consistent with forecasts in the report, a majority of members of the MPC expect to support a further cut in the rate at one of its forthcoming meetings this year, which would take it "close to, but a little above, zero".

Reaction

The pound was the first to react, falling from $1.334 against the dollar to $1.315, while against the euro slipped from 1.1982 to 1.1797 before rebounding slightly.

Economist Sam Tombs at Pantheon Macroeconomics said the Bank's actions exceeded expectations, but he felt it was "too sanguine" on the inflation outlook.

"The Committee...has regularly underestimated the impact of past exchange rate movements on inflation. By our reckoning, CPI inflation could pick up to 3% late next year, comfortably above the Committee’s expectations, potentially calling time on further stimulus."

Furthermore, Tombs said he doubted the MPC's actions will do much to stimulate the economy, with the proportion of the population holding a mortgage having fallen to just 30% from 40% a decade ago, and with 55% of borrowers now on fixed-rate mortgages, up from 35% three years ago.

"Debt interest payments therefore are likely to fall only slightly. Meanwhile, firms are holding back from investment because of chronic economic uncertainty, not the cost of credit. Lower rates will put more pressure on banks’ profitability and pension fund deficits. The onus therefore will be on fiscal policy to lean against the Brexit headwinds over the next year."

Martin Beck, senior economic advisor to the EY ITEM Club, said while the three elements of the MPC’s plan may individually only have a relatively modest impact, "combined they represent a loosening of policy which is towards the top end of the range that anyone could have realistically anticipated".

Having previously talked about the policy dilemma raised by the prospect of higher inflation and lower growth, Beck said 'Super Thursday' saw the MPC "has clearly prioritised supporting growth, with looser policy coming despite the MPC anticipating that inflation will be some way above target through the second half of its forecast".

He added: “There is also a clear commitment to loosen policy further, even if the outlook evolves in line with the MPC’s new forecast. With the Chancellor also being “prepared to take any necessary steps to support the economy and promote confidence” we look set to see a substantial loosening of policy over the second half of the year which should act as a powerful defence against a Brexit-induced slowdown.”

More action may well be needed, and not just from the Bank of England, said Chris Williamson at Markit., turning the focus towards the Chancellor’s Autumn Statement, which will outline the extent to which fiscal policy will be used to provide additional support to the economy.

"The overriding concern is that the Bank can reduce the cost of credit and encourage more lending, but it can do little to boost the demand for lending and spur spending if business and households are worried about the outlook,” he added.