Just how severe are the economic consequences of the Brexit vote? Well, we have just received the first real policy response to the unfolding picture. The Bank of England has responded to the fallout of the Brexit vote by lowering its interest rate to a historical low of 0.25 percent.
Along with this reduction, Mark Carney, governor of the BoE, made a statement similar to that of Mario Draghi, president of the European Central Bank, who said, "Within our mandate, the ECB is ready to do whatever it takes to preserve the euro."
Mr. Carney said that the BoE would "provide support" for whatever the economy needs in the future and will use "all the tools thought possible." Right now, besides the reduction in the bank rate, Mr. Carney announced a £70 billion bond-buying program and a new £100 billion program for funding banks. The immediate market response was a decline in the yield on the 10-year government note to 0.63 percent and a decline in the value of the British pound to around $1.31, although it dropped below this price in early morning trading.
This was a new low for the 10-year interest rate, but the value of the pound was still above the recent low of about $1.29. The day of the Brexit vote, the value of the British pound was around $1.49.
And the shape of the economy? The BoE is projecting that the growth in the third quarter of 2016 will be around 0.1 percent with "stagnation" for the following six to nine months. Unemployment is to rise, housing prices are to fall, as will household incomes.
Again, we see central banks wanting to err on the side of being too aggressive. But Mr. Carney indicated that it was highly possible that there would be more to do, and especially mentioned that another interest rate cut was probably in the books. Funny, we were just concerned about the Fed not raising its interest rate. However, that is the state of the world today.
Economic growth in the United States is not where people would like it to be. The European Union is not doing so well economically, and its central bank continues to push on its quantitative easing and possibly lower interest rates to even more negative values. And, here we have Great Britain facing a "no growth" situation with its central bank on the edge of a zero interest rate. The rest of the world is not doing that well either.
And what about the distortions that are being produced in such an environment? Negative interest rates? And stock markets like those in the United States that have just recently hit historical highs?
It is such a distorted world that even an investor like Bill Gross of Janus Global talks about buying assets that are not being impacted by the Fed.
And, what about financial institutions? Can banks, insurance companies, and pension funds exist in a world where interest rates are around zero? As net interest margins continue to fall, banks and other financial institutions stretch to protect earnings. But how long can they go on?
It just seems as if the world is in a downward spiral. The Federal Reserve doesn't raise interest rates, so the European Central Bank does. Then, the Bank of England cuts its rate. And the Federal Reserve falls under pressure to, once again, lower its rate.
Where does this stop? I think that with everything the British have to do to protect their economy, the value of the pound, as I have suggested before, will drop to at least $1.25.
The question is, when will the war between the central banks end?
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