BoE’s Brexit Battleplan - ING

Research Team at ING, suggests that the fallout from an on-hold BoE last week has been limited, with the MPC sending out a strong signal that additional easing is likely to be announced in August.

Key Quotes

“Chief Economist Andy Haldane recently said that a ‘package’ of measures will need to be delivered ‘promptly as well as muscularly’. In this note, we take a closer look at what this package could look like and argue that limited scope for aggressive Bank rate cuts means that the resumption of QE next month is necessary to offset the Brexit uncertainty shock. While markets have all but priced in a 25bp rate cut, we think a £50bn QE announcement in August would drive gilt yields and GBP lower.

Our base case for the August MPC meeting is: (1) a 25bp rate cut; (2) an initial £50bn expansion of QE asset purchases (mainly conventional gilts); and (3) the announcement of further credit easing initiatives such as the Funding for Lending Scheme (FLS).

Why does the BoE need to look at QE and other unconventional tools?

• While there are more direct economic merits to lowering Bank rate, a desire to avoid negative rates and limit any adverse impact on bank margins means that we see the BoE ultimately restricted to two further rate cuts. We think the MPC will therefore need to dip into its unconventional policy toolkit to deliver a sizable near-term policy stimulus.
• The primary purpose of QE this time round is to boost confidence. Evidence since Brexit, most notably from the flash PMIs (which fell by the sharpest amount in history), indicates that firms are taking a much more cautious approach to hiring and investment.
• Our estimates show that the uncertainty effects stemming from a Brexit could lower UK GDP by 0.8% and would require a £50-60bn initial QE stimulus to offset this shock.

Risks of a dovish BoE surprise?

• With a 25bp rate cut all but priced in, any dovish BoE surprise next month is more likely to come from an announcement of a larger-than-anticipated QE expansion.
• We think the balance of risks lie to the upside on our £50bn QE call given that: (a) the post-Brexit uncertainty shock may turn out to be larger than predicted; and (b) the stock of eligible gilts does not provide any material buying constraints.

What are the market implications of a BoE QE announcement?

• We suspect the portfolio rebalancing channel may be less potent than before and only a sizable BoE QE announcement (£50bn or more) will have a meaningful market impact.
• Recent GBP moves have been driven more by rate cut expectations as opposed to QE speculation (in contrast to 2009 where the anticipation of QE drove cable c.2-3% lower). Greater BoE QE easing calls ahead of the Aug meeting has scope to weigh on GBP.
• We estimate that a £50bn surprise QE announcement would see the 10Y gilt yield fall by around 30bp. Outside risks of a punchier QE programme (closer to £100bn) could see GBP/USD trade down to 1.2700. We still look for cable to fall to 1.23 by 3Q16.”