Question 4

Evaluate the expected economic effects of the interest rate cuts by the Bank of England on the UK economy facing the coronavirus crisis, using information from Case Study II and concepts discussed earlier in question 3.(20 marks)

Reference

Case Study - II

Bank of England cuts interest rates to all-time low of 0.1%

Rishi Sunak will reveal plans to subsidise workers' wages to prevent hundreds of thousands of lay-offs on Friday as the Treasury comes under pressure to match the new Bank of England measures to limit the economic fallout from Covid-19.

Amid warnings from the Trades Union Congress (TUC) that time is running out to save jobs from being axed, the chancellor is understood to be working on the final details of the scheme, including how many workers should be covered, how long it should last for and how it should be delivered.

Sunak met the leaders of the TUC, the British Chambers of Commerce and the Confederation of British Industry as the bank cut interest rates to 0.1%, their lowest ever level, and launched a fresh 200bn money creation scheme.

The bank cut interest rates to an all-time low and increased its quantitative easing (a way of injecting new money to stimulate the economy) stimulus package following further panic in financial markets over the handling of the coronavirus outbreak.

The Bank made the decision at a special meeting of its rate-setting monetary policy committee on Thursday. It will also buy an additional 200bn of UK government and corporate bonds under a Quantitative Easing money-printing programme, designed to hold down the cost of borrowing and pump cash into the economy.

The Monetary Policy Committee at a special meeting on 19 March voted to cut bank rate to 0.1% and increase its holdings of UK government and corporate bonds by 200 billion.

It comes a week after the Bank cut rates from 0.75% to 0.25% to address the coronavirus crisis and adds to the pressure on Sunak to put forward further measures to prevent mass job lay-offs.

The chancellor is trying to finalise the details of a plan that would allow employers to put workers on part-time hours or lay them off without them losing all their income.

But plans to run a new compensation scheme through the computer systems at HMRC and the Department of Work and Pensions have faltered after it became clear the scale of the changes breached the capacity of both government departments.

The Bank of England governor, Andrew Bailey, said the central bank moved quickly to calm markets spooked by the growing number of deaths from Covid-19 and concerns that the world's major economies are likely to suffer the steepest falls in GDP since the 2008 financial crash.

Rumours that London would be forced into complete lockdown imminently had also played a part in panicking financial markets. "You could see that reflected in the rising value of the dollar, in bond yields and in bond spreads," Bailey said.

"The obvious increase in the pace and severity of Covid-19, which has built during the week, was something we had to assess and respond to, we can't wait for the hard economic data before we act," he added.

Bailey said he would use the extra 200bn of quantitative easing funding to act in the markets promptly, adding that all central banks were moving in the same direction. "I talk to central bank governors most days and while we make decisions with reference to our own mandates, it is not a surprise that we all are coming to the same conclusion over what to do."

Central bank officials are known to be nervous about a collapse in business and consumer confidence after a spike in the number of virus cases and deaths in the UK.

Speculation that ministers are close to announcing further spending commitments to underwrite workers' incomes, with vast extra borrowing needed to fund it, is also believed to be behind the move.

The pound rose in value after the announcement, having endured its fifth worst day of the century against the US dollar before falling back to 1.16 against the US dollar. Only 10 days ago sterling was valued at $1.30. The pound was also up 2.4% against the euro at (EURO)1.0887.

Britain's blue chip share index, the FTSE 100 leapt almost 200 points following the move to close up 1.4% at 5,152. Continental stock markets followed the upswing with the German Dax closing up 2% while the French CAC rallied 2.7%.

Oil prices also recovered, adding more than $3 a barrel or 12.5% to the price of Brent crude, which reached $30 per barrel.

The Bank of England move follows the creation of a (EURO)750bn (637bn) emergency fund by the European Central Bank to extend its bond buying programme and shore up sovereign and corporate debt eurozone.

Bailey said that without the Bank of England's rate cut and stimulus package it was likely the volatility seen in markets over recent days would have worsened.

Replying to suggestions that the central bank had used all its ammunition to support the economy, he said: "We are not done. The Bank of England will do what the public needs in the days and weeks ahead."

Analysts at Japanese investment bank Nomura said the cut in interest rates and boost to quantitative easing was "highly unlikely to prevent a sizeable hit to [UK] Gross Domestic Product this year", but they added "there can be no question that the monetary and fiscal authorities are throwing everything they can at this problem to support firms and households, cushion demand as much as is reasonably possible, and to reduce the long-term hit to supply".

Karen Ward, a senior analyst at JP Morgan Asset Management, and a former Treasury adviser, said: "It is the additional quantitative easing in today's Bank of England package that will have the most significant impact, both in terms of the market reaction but also a solution to the economic challenges presented by Covid-19.

Ward added: "The support to the economy and health system will require vastly higher government borrowing. The central bank showing willing to buy government debt will ensure the market can absorb this additional issuance without undue stress".

(Source: Monaghan and Inman, 2020)