Why Interest Rates May Be Cut Again in November

The Bank of England may have chosen to keep rates at 0.25% yesterday - but there may be further cuts to come as Britain's economy digests the impact of Brexit

Emma Wall 16 September, 2016 | 11:50AM
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Emma Wall: Hello and welcome to the Morningstar Series "Market Reaction". I'm Emma Wall and I'm joined today by Alexis Gray, European Economist for Vanguard.

Hi Alexis.

Alexis Gray: Hi.

Wall: So yesterday we heard from the Bank of England, that the MPC had made the decision to hold rates in September. However, a closer inspection of the minutes showed that they will possibly be cutting rates in November. We've had positive economic data since Brexit. So why would they be considering a rate cut in November?

Gray: Well, I certainly think it's true Emma that in the last few weeks that the economic data for the U.K. has been better than expected. But let's put this into context. I think after the leave vote it's clear that this Brexit story has had a negative impact and that the U.K. has headed into a sharp downturn.

Now whether or not that’s going to be an outright recession remains to be seen. But I think given the position that the economy is in now, which is quite soft, it’s prudent that the Bank of England has done such a big stimulus and is leaving on the table the possibility of a rate cut.

In fact, what they said yesterday was that at the November meeting if we continue to see soft data that there is likely to be a policy cut. So we'll get interest rates dropping close to zero and I don’t think it's clear though whether we are going to get further quantitative easing, but a policy cut seems more likely than not.

Wall: One of the things that we have seen on the ground, the impact of Brexit has been a weaker sterling and to cut rates further would indeed support that low value of sterling. This has not been positive for U.K. holiday makers but it is actually quite good for the economy isn’t it.

Gray: That’s true. I think the sharp depreciation in sterling is actually buffer to the economy, when it's going through the sort of soft patch. I think the effect of Brexit is to raise uncertainty. So right now for a U.K. business they are not clear exactly what the relationship would be with the European Union going forward. So what we are seeing is businesses holding off making large investment decisions. So I think if you see that fall in sterling it actually raises the competitiveness of local businesses. They are selling to foreigners and now they look a lot cheaper. So that’s good news.

Now of course there is this upside and downside to a weaker sterling for a holiday maker going abroad its more expensive, but as I said it raises the competitiveness of U.K. businesses. So I think on the whole it's a good thing.

Wall: And of course yesterday wasn’t just the latest MPC meeting. It was also the 8th year anniversary of the collapse of Lehman's the bank which sort of signaled the beginning of the global recession. Before we had the Brexit vote there were lot of people suggesting that should the Britain leave the EU we would actually undo all the growth that we have made as an economy since that global recession. Do you think we are heading in that direction?

Gray: Look I think the collapse of Lehman Brothers was a very significant event, but not really comparable to Brexit. I mean Brexit is sort of an isolated U.K. event. So far we have seen that the negative consequences on the economy have been for the most part isolated to the U.K. we haven’t seen much of an impact in Europe and certainly in U.S. and China and other sort of countries further abroad. We are not seeing much of an impact.

Now Lehman collapse was a global, recession a global financial crisis so much larger event. And I also think with Brexit we're still early days. So although we know, we are going to leave the European Union, we don’t actually know how that trade relationship is going to work, whether immigration flows will be cut off.

There are two broad pathways we could take, which is a hard break, the hard Brexit, where as I mentioned all the trade links and immigrations close down. Or a softer Brexit which is similar to what we have today. But that uncertainty alone I think will weigh on the U.K. economy. But we can't say yet how big this is going to be.

Wall: Alexis, thank you very much.

Gray: Thank you.

Wall: This is Emma Wall from Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar

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