Base Rate Cut, Is It Enough?

Base Rate Cut, Is It Enough?

The Bank of England’s surprisingly broad range of attempts to fend off a recession in the wake of the Brexit referendum has met only a half-hearted welcome from big business.

The Confederation of British Industry said the unprecedented cut in the base interest rate to just 0.25%, the lowest rate in the bank’s 322-year history, and broader moves by the bank to improve capital liquidity should give a “shot in the arm” to corporate activity.

But most business groups warned that interest rates were already so low, having been held at 0.5% for seven years, that the latest cut would have only a limited impact.

The Institute of Directors (IoD) said what was really needed was decisive government budget action to lift business confidence, especially with the Bank of England predicting that its latest stimulatory package would barely hold off a recession by keeping growth just above zero for the second half of this year.

Heavy-lifting

The bank’s grim forecast that growth in 2017 would be just 0.8%, rather than the 2.3% it was predicting before the referendum, meant that the government rather than the bank had to do the ‘heavy-lifting’ to improve the corporate outlook, the Institute said.

The bank indicated it was willing to cut interest rates even further in the coming months if the economy performed as poorly as expected, but IoD economist James Sproule warned that the cost of capital “is not the major factor for business at the moment.”

A survey of IoD members this week had shown that six in 10 thought an interest rate cut would not have a discernible effect on business performance, he said.

The bank, government and confidence

“In the aftermath of the referendum, the Bank of England’s credibility in promising it would do whatever it took to maintain market liquidity was very important. But the problem now is confidence, not liquidity or access to capital.

“The bank cannot do the heavy-lifting on boosting business confidence; the government has to play its part. The real test of confidence is going to be the Autumn Statement, which could be usefully brought forward several weeks.

“We would like to see moves to raise the Annual Investment Allowance to half a million pounds, which would encourage business to buy productivity-raising new machinery. Delaying the introduction of the badly designed Apprenticeship Levy would also remove one short-term regulatory headache for firms.”

 

“what’s now most important to businesses is that the government develops a clear plan and timetable for EU negotiations”

 

Rain Newton-Smith, director and chief economist, CBI

Rain Newton-Smith, director and chief economist at the Confederation of British Industry (CBI), said that while the bank’s latest efforts would lower borrowing costs, “what’s now most important to businesses is that the government develops a clear plan and timetable for EU negotiations.

“At the same time, it must press ahead with domestic policy priorities, especially infrastructure decisions, which will allow firms to get on with serving their customers and investing for the future.”

The cut in interest rates was widely anticipated after the deterioration in many economic indicators and business confidence ratings in the six weeks since the vote to leave the EU but most business leaders were pleasantly surprised by the bank’s decision to also increase its quantitative easing (QE) programme by buying another £60bn of government bonds alongside a new programme buying £10bn of corporate bonds.

New schemes

The bank’s deputy governor, Minouche Shafik, said about 150 firms from outside the financial sector would be eligible for the new corporate bond buying scheme.

The bank also unveiled a new Term Funding Scheme that will lend banks up to £100bn at rates close to the new 0.25% base rate in a bid to push them to pass on the lower interest rates to businesses and households.

Dr Adam Marshall, the acting director general of the British Chambers of Commerce, said those measures would be more valuable than the cut in interest rates “when rates are already so low.”

“The additional measures, expanding QE, purchasing corporate bonds and the new Term Funding Scheme … will be welcomed by business. The Term Funding Scheme in particular will help to ensure businesses benefit from cheaper loans so they can invest and grow,” he said.

“The Monetary Policy Committee [MPC] indicated that despite the historic low of 0.25%, the base rate could be cut even further in the coming months. Further rate cuts are unlikely to stimulate the real economy significantly, and also bring the threat of negative interest rates on businesses’ deposits, which will be of significant concern to some.

 

“It is likely that deposits will reduce as people save less and/or move their savings into other investments”

 

Gianluca Corradi, director of commercial and business banking practice, Kucher & Partners

“Instead of further cuts to rates in the future, the MPC should give careful consideration to developing the other measures announced in order to drive longer-term UK business growth.

“This could be through further purchases of business bonds, and expanding the scope of their intervention to include investments in the UK’s ageing infrastructure in key areas such as transport and communications.”

A gloomy outlook

A firm word of warning about the Bank of England’s campaign to lower the cost of borrowing came from the prominent pricing strategy consultants Simon-Kucher & Partners, which said it could have a negative impact on banks.

Gianluca Corradi, the firm’s director of commercial and business banking practice, said bank reserves might suffer as customers entered a new round of moving their deposits to alternative investments.

“It is likely that deposits will reduce as people save less and/or move their savings into other investments. This raises the possibility of a deterioration of liquidity positions of many banks, resulting in higher lending costs and/or reduction in lending activity of some banks.”

The Bank of England’s gloomy outlook on the impact of the Brexit vote was shared by other analysts, such as Scott Corfe, director of the Centre for Economics and Business Research (CEBR).

"Even with this stimulus, CEBR expects economic growth to slow from about 1.5% this year to less than 0.5% in 2017,” he said.

"A recession – at least a couple of quarters of negative growth – will be difficult to avoid and unemployment is likely to rise from current levels.”

Peter Hemington, head of corporate finance at the accountancy and business advisory firm BDO, said the outlook for business was tough enough to justify the bank’s actions.

“Lower interest rates will be good news for our struggling manufacturing sector as it will make British exports more attractive. We now need a concerted effort from government to lay the foundations for future growth.

“That means taking advantage of cheap borrowing costs to invest in UK infrastructure, encouraging prosperity across the regions and improving productivity.”

 

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