The BOE and its warranted easing move

Undoubtedly the market was pricing some sort of action from the Bank of England (BOE), as the Brexit repercussions on the economy would turn severe if no action plan was in place. The interesting bit, is the fact that markets possibly failed to price in such an immediate aggressive easing.

A rate cut was warranted, with the BOE rate-setting committee cutting interest rates for the first time in nearly seven and a half years, from 0.5 percent to 0.25 percent. Other than that the committee also signaled the possibility of a further cut towards the end of the year.

The other surprising measures were the new Term Funding Scheme worth up to GBP100 billion and the purchase of up to GBP10 billion in U.K. corporate bonds The corporate bond-buying program is expected to be limited to firms making a material contribution to the U.K. economy.

In addition, the bond buying program better known as quantitative easing was increased by GBP60 billion of monthly purchases from GBP375bn to GBP435bn.

The immediate announced monetary easing is in line with the BOE biggest quarterly downgrade of growth forecasts, which reduced expectations for 2017 growth from 2.3 percent to 0.8 percent, following the huge uncertainty the UK economy will be facing in the coming months. The weakness in sterling ensued following QE and is now down 9 percent against a basket of currencies since the June vote. This may help exports as well as raising the price of imports for U.K. consumers.

Post announcement, despite the Governor indicating that negative interest rates should be avoided, the struggle to revive the economy might put further pressure on the BOE to cut interest rates further, even possibly as a detriment towards the banking sector.

In my view, the interesting bit is yet to come. The question I pose is what will be the ECB’s reaction now following the expected remarkable decline in the Sterling versus the Euro. The movement in currency might tamper the ECB’s progress in combating its inflation worries. Despite some economists’ forwarded views of a possible coordination in terms of easing measures, markets are preempting further easing measures by the ECB.

Market reaction was promptly noticed within the fixed income markets, as investors dashed into credit with the prime beneficiaries being U.S. high yield market which rallied by 0.74 per cent as investors continued to fetch attractive yields elsewhere.

In my view, yesterday’s BOE move will impose a short-term market rally, however investors should undoubtedly consider a more long term fundamental and its implications.