The central bank of the United Kingdom cut its benchmark Bank Rate by 25 basis points to 0.25 percent and launched a broad package of measures to support economic growth and inflation that includes the purchase of up to 10 billion pounds of corporate bonds, an expansion of its existing asset purchase scheme by 60 billion pounds and a new Term Funding Scheme (TFS) to ensure that households and firms benefit from the stimulus by providing funds for banks.
It is the first rate cut by the Bank of England (BOE) since March 2009 and comes six weeks after voters in the U.K. elected to leave the European Union (EU), which weakened the outlook for growth and triggered a sharp fall in the pound's exchange rate that is likely to push up short-term inflation above the BOE's 2 percent target as higher import prices are passed through to consumer prices.
But after the impact of the lower exchange rate on inflation dissipates, the BOE expects inflation to fall back down due to weak demand and said its stimulus measures were specifically aimed at reducing the spare capacity in the economy to ensure that inflation settles around its target.
Each element of the BOE's package of stimulus measures can be adjusted and if new economic data is consistent with the BOE's forecast, "a majority of members expects to support a further cut in Bank Rate to its effective lower bound at one of the MPC's forthcoming meetings during the course of the year," the central bank said, adding this lower bound was considered to be "close to, but a little above, zero."
"The decision to leave the European Union marks a regime change," BOE Governor Mark Carney said in his remarks to a press conference.
"In the coming years, the UK will redefine its opens to the movement of goods, services, people and capital," he said, adding that this adjustment may prove difficult but expressed confidence that the UK could handle it as it has one of the most flexible economies in the world, with its people "admitted the world over for their strength under adversity."
The rate cut and the TFS was approved by a unanimous vote by the BOE's 9-member Monetary Policy Committee (MPC). But only eight members supported the corporate bond schemed and six voted for further purchases of UK government bonds.
While Carney said the BOE's measures cannot fully offset such a large structural shock as leaving the UK, it can support the necessary adjustment during "a period of heightened uncertainty."
The BOE's rate cut and stimulus measures were widely expected by investors and financial markets and comes after the BOE last month stayed its hand while waiting for concrete data on how the economy was reacting to the uncertainty triggered by the June 23 vote to leave the EU.
The exchange rate of the pound has fallen around 9 percent since the EU referendum - known as Brexit - and while this will help UK exports, the BOE doesn't expect it to fully offset the drag from a substantial weakening of private domestic demand from higher unemployment and lower businesses investment during the period of uncertainty and lower real estate markets.
BOE staff have now updated their economic forecasts and slashed its outlook for economic growth in 2017 to 0.8 percent, based on the modal, from its previous inflation report in May of 2.3 percent. The outlook for 2016 growth was maintained at 2.0 percent while the 2018 forecast was cut to 1.8 percent from 2.3 percent.
Inflation in the third quarter of next year was seen rising to 1.9 percent from an unchanged 0.8 percent this year, but up from the previous projection of 1.5 percent. In the third quarter of 2018 consumer price inflation is seen rising to 2.4 percent, up from 2.1 percent, and then remaining at 2.4 percent in the third quarter of 2019.
The projections were based on market interest rates implying that the Bank Rate would by cut to 0.1 percent by the third quarter of next year and remaining at that level through the third quarter of 2018 before rising to 0.2 percent by the third quarter of 2019.
Carney described the BOE's measures as "timely" because the combination of a weaker outlook and lags in the transmission of monetary policy dictated the need for stimulus now.
The rate cut will immediately ease the financing conditions for households and firms as around half of mortgages have floating rate contracts and more than four-fifths of bank loans by firms are at floating rates.
However, given that rates are already very low, the BOE recognizes that its rate cut may not be fully passed on to households and firms, noting that in some cases borrowers in Europe have faced rising interest rates despite lower central bank rates.
To tackle that, the BOE is launching the Term Funding Scheme, which allows UK banks and building societies to borrow up to 100 billion pounds over the next year to reinforce its rate cut, reduce the effective lower bound of the Bank Rate to close to but a little above zero, charges a penalty if banks don't lend and covers all types of lending.
The new stimulus measures will be financed by the BOE electronically crediting banks' reserves held at it. By boosting its government bond purchases by 60 billion pounds, its total stock of such assets will rise to 435 billion.
Supporting the BOE's stimulus is a decision by the Financial Policy Committee to amend the leverage ratio for UK banks to exclude central bank reserves and an earlier decision to increase the availability of credit by up to 150 billion pounds by cutting the counter-cyclical buffer to zero.
The Bank of England issued the following statement: