The decision by the Bank of England – the UK's central bank – to cut its interest rate to 0.25 per cent is designed to provide monetary stimulus to an economy struggling to avoid recession. The cut, the first in seven years, takes interest rates to their lowest since 1694 when the Bank of England was formed. Financial markets fully anticipated the move which follows increasing evidence since the Brexit vote of a sharp slowdown in the services industry, the largest segment of the UK economy. This sector, a recent survey shows, has just experienced its largest month-on-month decline on record.
Bank of England Governor Mark Carney described the Brexit decision as marking a regime change; a large structural shock to the UK economy and one that could not be offset by monetary policy alone. In lowering the cost of credit and using quantitative easing measures to inject more money into the financial system, the bank is providing support to an economy beset by the uncertainty surrounding Britain's future relationship with the EU. Since the vote in June, sterling has depreciated by nine per cent, with lower interest rates placing the currency under further downward pressure. A weaker pound makes British imports (and Irish exports to the UK) more expensive and means higher inflation. The latter is expected to reach 2.5 per cent in 2018, with unemployment rising to 5.5 per cent in that period.
The mandate of the Bank of England requires it to balance and reconcile different objectives: price stability – low inflation – with support for growth and employment. In defending the bank’s monetary policy decisions, Mr Carney insisted that failure to act as it has would mean higher unemployment and lower output. As the governor admitted, Brexit will prove difficult and it will take time to adjust to new realities – whatever these may be – and to seize new opportunities. For now, the Bank of England’s immediate challenge is how best to help ensure the British economy avoids recession, using the limited available monetary policy instruments – further rate cuts and more quantitative easing – if it has to do so.