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What’s Behind the UK’s Decision to Hold Off on a Rate Cut?

While the Federal Reserve slashed its interest rates by 50 basis points this week, and are expected to ease further at their March meeting, Andrew Bailey took a contrarian stance by stating that a rate cut for the UK is not imminent.
Jignesh Davda
Bank of England

The Federal Reserve saw the risks arising from the Coronavirus great enough to do two things this week.

  • They cut rates by 50 basis points rather than the usual 25 basis points.
  • They did so ahead of their scheduled meeting in two weeks

These two points speak volumes about the urgency of the situation. The last time they delivered a 50 basis point cut was about 12 years ago. Further, the markets are fully pricing in another 25 basis point cut at the scheduled March 18 meeting and have started to get aggressive in ramping up the odds for a larger 50 basis point cut instead.

Despite this, Andrew Bailey, who will be replacing Bank of England Governor Mark Carney on March 16, suggested this week that a rate cut from the BoE was not imminent.

The Biggest Central Banks Around the World Want to Ease Policy

Bailey seems to be on his own in his view. Three of the major central banks have cut rates this week. The ones that didn’t mostly fell in the category of not having the capacity to do so. To be clear, the BoE can reduce rates and Bailey reiterated what others have said, that the interest rate in the UK has room to go as low as 0.1% from its current 0.75%.

Aside from the Fed, the Bank of Canada and Reserve Bank of Australia reduced their interest rates this week. The BoC is of particular interest as it’s last policy move was a rate hike in September of 2018. Further, they stand ready to ease more if necessary.

The Bank of Japan wants to ease policy but is understandably in a difficult position as its rates are already negative. Nevertheless, Reuters reported that a majority of economists that they surveyed expected that the BoJ will ease monetary policy by increasing asset purchases.

The European Central Bank is in a similar position with negative interest rates and a further rate cut might not provide the desired effect. Nevertheless, the ECB is expected to cut their rates by another 10 basis points at their meeting next week. Further, the ECB may look to support the economy via asset purchases.

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The Bank of England Wanted to Cut Rates in January

Several MPC members signaled their readiness to cut rates in early January. In fact, two members have been voting for a rate cut since the November BoE meeting.

The Bank of England did not end up cutting rates in January as incoming data pointed to a recovery in both services and manufacturing while the employment rate rose to a record high in January.

Positive data continued in February for the UK with sharp rebounds mostly across the board in headline data. While this is extremely encouraging for the UK, it is important to acknowledge that a recovery was generally expected after the December election.

In addition to that, the US economy is in good shape and the Fed still saw the need to cut rates. This was acknowledged in the statement that accompanied the rate cut earlier this week which read – “The fundamentals of the US economy remain strong. However, the Coronavirus poses evolving risks to economic activity.”

The BoE Seems to Want to Act

What’s most surprising is that several recent statements seem to suggest that the Bank of England wants to take action.

Earlier this week, BoE Governor Carney said: “The Bank will take all necessary steps to support the UK economy and the financial system.” The financial markets typically interpret this type of statement that a rate cut is coming.

To be clear, Bailey’s comment does not suggest complacency regarding the virus. Rather, it is surprising that action was not taken this week and that he did not see the threat as urgent as almost every other central banker sees it.

Bottom Line

Rate cuts take time to filter through the system before having a positive impact on the economy. The Fed has taken a proactive and forward-looking position by acknowledging the risks and taking action.

Bailey’s decision to wait and assess further is a contrarian approach. Perhaps his view will pay off and the Coronavirus risks are not as great as they may seem to be. I’m certainly rooting for this scenario, I’d rather see this situation get resolved than escalate further. However, this would mean that most of the smartest economists of the world were wrong in their view. It could happen, but it’s not something I would count on.

Based on comments from Bailey and Carney, it does seem the BoE will act. Bailey seems to be focused on a correlated effort with the government that may involve fiscal stimulus. But if that’s the direction things are heading in, it begs the question, why wait to reduce rates by a quarter point now? They can always reduce further if need be, or raise rates if the action seemed unnecessary after the fact. Considering what everyone else is doing, the adage “It’s better to be safe than sorry” appears to be appropriate.

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