Somewhat surprisingly, at its July meeting, the Bank of England’s monetary policy committee refrained from unveiling any stimulus measures for the UK economy. However, while the MPC took no action last week, it was quite clear that it expects to ease policy in August. So, what should we expect policymakers to do in August and, if they’re so sure they want to ease, why did they wait?
The reason for waiting seems to be driven by uncertainty about what the appropriate size of the easing should be. In the August meeting, the BoE will issue its next quarterly inflation report, and so by waiting the MPC will gain the benefit of seeing a full staff analysis of the macroeconomic implications of the Brexit vote to leave the EU.
Furthermore, although most of the normal economic data released between now and the August meeting will be of data that refer to the period just before the referendum, the extra six weeks gives the Bank time to speak with its contacts in business and financial markets to assess the near-term impact and get a sense of how urgent the situation may be.
In this context, one implication of its choice to defer seems to be that it’s not a given that the policymakers will deliver a particularly large easing by the standards of the post-financial crisis world. It seems unlikely they would have been bothered by following moderate easing measures in July with additional stimulus in August; what they certainly would have wanted to avoid would have been easing in July only to withdraw some of the stimulus at the very next meeting.
This leads naturally to the question of what we should expect in August. The policy implications of Brexit are not nearly as clear as is often supposed. While there is virtual unanimity that leaving the EU will make Britain poorer in the long run, the economics of the short-run reaction are ambiguous. On one hand it is clear that certain types of investment look a lot less attractive in the post-referendum world; by contrast, the persistent fall in the value of the pound supports the external sector, making investments within it look more attractive.
Over the long term the UK is unambiguously poorer as a result of the vote, but this comes about not from a reduction in aggregate demand but from lower productivity growth. There is general consensus in the academic trade literature that firms that sell internationally are more productive, in the sense that the most productive firms are the ones that compete globally but also that competing globally tends to make firms more productive. Just as trade tends to take the most productive firms and make them even more so, reducing opportunities for trade would likely have the opposite effect.
So, what can monetary policy actually do to help here? Well, it can certainly keep the pound from retracing its depreciation. It seems likely that validating the selloff in sterling is one reason that the MPC is so sure that some easing is a good idea. Beyond that it appears most of the desire to ease reflects a desire for downside protection. For example, the usually somewhat hawkish member Martin Weale suggested that risking an inflation overshoot was preferable to risking a recession.
Here the fundamental uncertainty appears to work in favour of an easing but again, does not seem to indicate a very substantial easing package until the hard economic data make such a move clearly necessary. All in all, this is sounding like a token interest rate cut, perhaps 0.5 per cent to take the Bank Rate down to zero, but nothing more for the time being. That and, of course, all sorts of lip service to the effect that much more will be coming at a moment’s notice if the need appears to arise.
Adam Purzitsky is co-head of the Absolute Return Government Bond team at Old Mutual Global Investors.