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Bank of England deploys aggressive policy arsenal

Mike Amey   |  05 Aug 2016Text size  Decrease  Increase  |  

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The Bank of England's four policy moves certainly constitute a decisive and comprehensive package, but will it work and what are the investment implications?

 

With its first policy move in four years and first interest-rate move in seven years, the Bank of England's Monetary Policy Committee has very much embraced the view that if you decide to ease, then be aggressive.

When your economy is approaching the zero lower bound on interest rates and intermediate gilt yields are already well below 1 per cent, it makes sense to use what modest monetary scope you have as decisively as you can.

Thursday's four policy moves to cut interest rates to 0.25 per cent, restart quantitative easing, initiate a corporate bond buying programme and provide financing support to the banking system certainly constitute a decisive and comprehensive package.

Now the two critical questions are will it work, and what are the investment implications?

Economic outlook

Whether it is likely to work is best explained by looking at the BOE's growth and inflation forecasts, which are very similar to PIMCO's.

UK growth is expected to fall to just above zero for the next twelve months, and then rise back up to 2 per cent by 2018-2019.

Headline inflation is expected to rise to 2.5 per cent and fall back slowly to the 2 per cent target thereafter.

This represents a relatively benign outlook, and assuming the new Chancellor announces some reversal of the previous plan to further tighten fiscal policy, there looks to be a good chance these forecasts will be realised.

Given the speed of deterioration in the purchasing managers' index and other surveys released post the Brexit vote, there are clearly risks to the outlook, but the new policy measures should go some way to negating those risks.

Market implications

Of particular note is that the BOE's asset purchase programme will take six months to complete and the corporate bond purchase programme is intended to be completed over an 18-month period.

This suggests monetary policy will remain highly accommodative for much of the cyclical horizon, keeping the damper on shorter- to medium-term UK sovereign yields despite the fact that many are already hitting new lows.

In relative terms, longer-dated (30-year) gilts yielding around 1.5 per cent are becoming more attractive versus shorter maturities, where yields are around 0.1 per cent on the two-year and 0.7 per cent on the 10-year.

Meanwhile, the British pound has been weak Thursday, but is still at levels above those seen in the last month.

In summary, we expect longer-term gilt yields should be supported by the BOE policy moves and the broader economic environment, while the British pound looks to have scope to go lower.

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Mike Amey is head of sterling portfolios at PIMCO. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

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