Today (Wednesday 11th March), the Bank of England surprised the market with an emergency -50 basis points cut to its interest rate. The move from +0.75% down to +0.25% came just two weeks before the next scheduled meeting and was a final parting shot from outgoing Governor Mark Carney. The economic impact of the Coronavirus was cited as the reason, but sterling traders have taken the move with a fair degree of acceptance. Much of this comes from the room the BoE has to play with, and some from other measures they have implemented alongside the rate cut. Once you add in the UK Annual Budget which comprises a package of fiscal stimulus measures, looking past the recent volatility, the outlook for sterling remains supported with a medium-term positive bias.
Bank of England emergency rate cut
A Bank of England rate cut of -50 basis points came as a surprise but was more of a headline-grabbing measure. In the spirit of recent dovish central bank moves in response to Coronavirus, Short Sterling Interest Rate futures markets had been pricing for between 25 to 50 basis points of cuts at the next Monetary Policy Committee meeting on 26th March. The timing of the cut came as an initial surprise (and pulled GBP lower) but the move quickly steadied.
However, it has been the further measures of what which have really been the takeaway. There were two steps:
- A new “Term Funding Scheme” and additional measures for Small and Medium-sized Enterprises. As a way of providing extra funding to allow banks to pass on the rate cuts could provide more than £100bn in term funding.
- Cutting the CounterCyclical Buffer to zero. So as to help prevent obstacles in banks supplying credit to the economy for businesses and households. This will support up to £190bn of bank lending.
Is the Bank of England One and Done?
The forwards rates curve price for perhaps the Bank of England could perhaps cut another -15bps go to +0.10%. Subsequently, essentially at +0.25%, the market sees that BoE has made its move. Coming with the other measures for SMEs (see below), the BoE has gone bold, targeted and early, but also seems to be one and done. The efficacy of a further 15 basis points of cut will be minimal and do very little. It seems as though the Bank of England has looked to get ahead of the curve with these moves. The market also seems to be giving it the benefit of the doubt too.
Given the fact that other central banks (such as the Fed, Reserve Bank of Australia and the Bank of Canada have further room to cut will give sterling support on rate differentials.
A massive fiscal expansionary Budget
In addition to the Bank of England measures, the newly appointed UK Chancellor of the Exchequer, Rishi Sunak also delivered an Annual Budget containing a substantial fiscal stimulus.
A Budget of spending promises after years of belt-tightening from the Conservatives. This seems to be a significant change in tack by Boris Johnson’s Government compared to those of David Cameron and more recently Theresa May. A massive increase in spending for infrastructure projects, with £600bn pledged over the next five years on roads, rail, broadband and housing.
However, with these spending pledges, comes a massive increase in borrowing. The previous aims of cutting the budget deficit to zero have been completely thrown out of the window. Public Sector Borrowing is expected to rise to 2.1% in 2019/2020, then to 2.4% in 2020/2021 and up to 2.8% in 2021/2022. Considering the March 2019 expectation for 2022 was for a budget deficit of just 1.6% this is a sizeable increase in spending. To put this in context of borrowing numbers. It is an extra £29bn of borrowing in 2021/2022.
The immediate prospect of a negative shock for the economy has brought some immediate spending pledges – a total of £30bn fiscal stimulus to support the economy during the Coronavirus. These include £12bn on public services, businesses and individuals (£5bn extra for the NHS and public services, c. £1bn/£2bn to pay for small businesses to refund for statutory sick payments for two weeks (also allowing small businesses to access “small business interruption” loans of up to £1.2m.With regards to the business measures especially, in conjunction with the measures from the Bank of England this morning, this is being taken positively.
The impact on sterling
Market reaction has been positive to the moves laid out today. Volatility on the BoE move was understandable. The algorithm traders sold GBP instantly with around -100 pips lower on Cable on the rate cut. But then as the market digested the likelihood that the BoE had little room to go further in addition to the extra measures to help business, it was seen as GBP supportive. The support for GBP continued through the budget speech too.
One of the encouraging signs also is that there seems to be fiscal and monetary coordination for the UK to get through this Coronavirus crisis. It is still early days, but if the virus can be adequately contained, the measures are in place for the UK economy to ride out the storm.
We see GBP/USD as continuing to trade within this medium term range of almost 500 pips (between $1.2725/$1.3200). The measures introduced today should see GBP continuing to find support into the EU/UK trade negotiations. We see these trade negotiations as providing headline driven volatility but see GBP weakness as a chance to buy as the year progresses.