Scale of monetary firepower unleashed shakes markets

Everyone expected the Bank of England to cut interest rates and to pump some more money into the economy but the sheer scale of the monetary firepower unleashed on Thursday shook the markets. The pound, which had recovered some of its post-referendum losses in recent weeks, fell by 1.5 per cent against the dollar. The FTSE100 rose by 1.5 per cent as British government bond yields plunged to new lows.

The bank's decision to make up to £100 billion in extra funding available to banks reflects in part the fact that interest rates are now so low that further cuts tend to have a diminished impact. Governor Mark Carney said the extra funding left the banks with no excuse to avoid passing on the benefit of the latest rate cut to borrowers.

That measure, along with the decision to create an extra £70 billion to buy government and corporate bonds, is also an expression of the size of the challenge the decision to leave the EU presents for the British economy. Carney insisted that Britain was capable of rising to the occasion, but he made no bones about the overwhelmingly negative short-term impact of the Brexit vote.

The bank expects little or no economic growth for the rest of this year and weak growth in 2017, with unemployment and inflation expected to rise and house prices to fall.

The bank, which was criticised for responding too timidly to the financial crisis in 2008, made clear on Thursday that it will show no such restraint in responding to Brexit.

Protect from recession

Although Carney effectively ruled out negative interest rates, the rate could yet be cut from its current level of 0.25 per cent, and the governor signalled the bank’s willingness to use all the means at its disposal to protect Britain from a recession.

Chancellor of the exchequer Philip Hammond has already signalled a loosening of fiscal policy, abandoning the target set by his predecessor George Osborne to eliminate the budget deficit by 2020.

With the cost of government borrowing falling, Hammond may feel emboldened to launch an ambitious fiscal stimulus package in October. This could include major investment in infrastructure projects as well as tax cuts targeted to boost demand.

The uncertainty surrounding Britain's future relationship with the EU will, however, continue to inhibit investment and depress economic activity at least until Theresa May formulates her opening negotiating position. Business groups want Britain to remain part of the European single market, but that would involve a commitment to continued free movement of people from the EU.

With a working majority in the House of Commons of just 16, Ms May is under pressure from pro-Brexit MPs on the backbenches and within her own cabinet to fulfil the Leave campaign’s promise to “take back control” of immigration.

How she squares that circle is likely to have a greater impact on Britain’s long-term economic future than any amount of monetary artillery unleashed from Threadneedle Street.