BoE's Carney Counters Brexit Headwinds

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By Bill Witherell, Chief Global Economist

Last week the Bank of England (BoE) surprised markets by announcing a broader-than-expected monetary stimulus package. The BoE's first rate cut in seven years, by 25 basis points to 0.25%, was not a surprise. Unexpected, however, was an early restart of quantitative easing. The BoE will buy an additional 60 billion pounds sterling of government bonds ("gilts"). The Bank will also buy 10 billion pounds of corporate bonds. A further surprise was the announcement of a Term Funding Scheme that is designed to encourage banks to pass the interest rate cut on to businesses and households. Banks will be able to borrow from the BoE at close to the base rate on the condition that the funds are lent on to companies and households, passing on the rate cut.

Mark Carney, BoE governor, stated that the Bank was delivering this stimulus in order to counter the economic shock of the UK's decision to leave the European Union. He warned that despite these measures, 250,000 people are likely to lose their jobs due to depressed spending by both firms and households, as uncertainty about the UK's future trading relationships is likely to continue for an extended period. The BoE noted it stands ready to take further measures, if warranted.

The BoE forecasts that the economy will narrowly avoid recession. At best, it will be a very close call. The UK Purchasing Managers' Index for July tumbled to the lowest level since early 2013. Production declined the most since October of 2012 and was "... across firms of all sizes and across the consumer, intermediate and investment goods sectors…" There was some modest improvement for exporters due to the weaker pound. The BoE projected third-quarter growth at just 0.1%. Their forecast for 2017 has been downgraded from 2.3% (their forecast in May) to just 0.8% despite the massive monetary stimulus program. This forecast downgrade is the largest in 20 years for the BoE.

Attention is now turning to the upcoming UK government's Autumn Statement on fiscal policy. The new head of the UK Treasury, Philip Hammond, says he will "reset" tax and spending plans. In view of the UK's economic difficulties, it is anticipated that the Treasury will provide fiscal stimulus to complement the new monetary stimulus. The previous government's goal of balancing the budget by 2020 has been ditched by Prime Minister Theresa May.

The currency reacted sharply to the BoE's announcement, falling 1.5% against the US dollar and reversing the recovering trend that followed the pound's sharp decline after the Brexit vote. Despite the gloomy economic projections, UK stocks rose, adding to a recent improving trend in the domestic market. However, unhedged UK ETFs on the US market have suffered from the weak currency. The iShares MSCI United Kingdom ETF (NYSEARCA:EWU), was down 0.13% last week but up 5.27% over the past month. This contrasts with the iShares Currency Hedged MSCI United Kingdom ETF (NYSEARCA:HEWU), which rose 1.06% last week but just 3.56% last month. We are continuing to hold off on adding direct exposure to our International Equity ETF portfolios, as we consider the outlook still too uncertain.