Pressure eases on Bank of England to cut rates

Its been a catch 22 position for the Bank of England for the past few months. The bank had almost run out of options by the year-end 2019 when easing of rates any more than the prevailing levels would have led to the British Economy falling into a liquidity trap. The past few years the bank had followed a loose monetary policy on account of the struggling condition of the British Economy. However, the state of the sentiment among the British citizens and businesses was so low that it was not responding to the monetary stimulus. The state of fiscal and political affairs in the country was also not coming in support of the banks’ efforts to spur economic activities.

The bank has been in a fix whether its monetary policy stimulus was having any effect at all. Leading indicator after leading indicator were all trending in the negative direction, all indicating the onset of a long-term recessionary phase in the British Economy. Politically the lawmakers, though were aware of the dangerous situation created by the British Economy sliding into a downturn but were more busy with bickering amongst each other rather than trying to stabilize the choppy politico-economic climate that had gripped the country.

Brexit, or the United Kingdom’s parting ways with the European Union brought with it some unimagined and unanticipated eventualities that threatened to drag down the British Economy by several decades. The factors that were responsible for all the gains made by the British Economy while it was still a part of the European Union were now going to be redundant, leaving the Economy to fend for itself. The country would only need to fend for itself, but ironically it found itself bereft of any plan on how it wants to do that. This put a lot of confusion in the minds of businesses which were uncertain on how to deal with the situation. Most businesses in the country curtailed their business activities and either postponed or cancelled any upcoming capital investment program. The mood among the average citizens also started to wane regarding their future; consumer confidence index, housing prices and a host of other measures that gauge the sentiments of the British people, started trending in the negative. What exacerbated this already volatile situation was the worsening international economic situation, which ranged from trade war to economic slowdowns and was resulting in a drag on the entire world economy.

Internationally, the showdown between China and United States regarding bilateral trade tariffs was putting the world economy to maximum distress. The United States and China are the largest and second-largest economies in the world and also combining command over the largest proportion of international trade; a shortfall in these activities was indirectly affecting trading between other countries as well. The second international factor was the slowdown in the Chinese Economy. China is today the world’s largest manufacturer and also the largest importer of several basic commodities. With the slowdown in the Chinese economy and manufacturing activity taking a beating in that country, several of the countries whose economies depend on the export of basic commodities to China took a beating as well. The largest impact of the above was the fall in prices of major commodities and its ensuing impact on the production of these commodities. The United Kingdom, which is one of the largest trading partners of China, took a beating as well as several British companies who are invested in that country started to feel the effects of the slowdown.

Within the British Economy, the industries which are going to be affected the most are going to be the financial services sector, retail sector and the high-tech manufacturing sector. The financial services sector for a long time has been the most important of all sectors of the British Economy. The sector, which has been responsible for making London one of the most important financial destinations of the world, now was facing an unprecedented threat.  For years the who’s who of the financial world have made London their home and expanded their operations across Europe. With the passage of the Brexit event, there will be now fresh restrictions on the movement of people across the United Kingdom and rest of Europe, making it difficult for banks and financial institutions to centrally conduct their operations across Europe. The banks thus, now have to decentralize and have independent offices in the rest of Europe which at times may not be viable, leading to the threat of the entire industry gradually shrinking. In the British retail industry, raw materials for many of the goods merchandised in the United Kingdom were actually sourced from other low-cost countries in the European Union. Departure from the union due to Brexit in the short run will create a temporary shortfall of these commodities giving rise to price increase in the short run.  The British producers will struggle to fulfil the demand. The high-tech manufacturing sector will be the impacted most as this industry had for long relied on imported high tech components and skilled manpower to run the industry. With Brexit in place, the industry will struggle in short to mid-term as the necessary skillsets have eroded in the country over a long period of time and training new workforce cannot be implemented in the short run.

Given the above and several other structural problems that are evident as a consequence of Brexit, a simple monetary easing was not having its desired effect. Long term policy adjustments need to be made to take care of these structural deficiencies and lay the foundations for long term growth. Policy decisions thus are the key to dealing with such an extensive politico-economic events like Brexit. The monetary policy has only a limited role to play in matters like this; they are able to correct any temporary anomalies that might crop up in an economy in the short run.

The situation, incidentally, was not only isolated to the United Kingdom the Federal Reserve of the United States also in response to the worsening global economic situation had lowered interest rates when most of the economists and observers of the Federal reserve had anticipated a stable rate regimen. Similar was also the case with several other major European and Asian economies which responded the world economic downturn in 2008-09.

Within the country, the Bank of England has now a different situation staring at it altogether. While it is hard-pressed to allow a lit bit more of the interest rate to decline on account of the still overwhelmingly negative sloping economic indicators while some of the critical ones are witnessing a turnaround. Ever since the results of the December 2019 general elections, there is an increasing number of such indicators that have started to trend on the positive territory, one after the other. The consumer confidence index, the new hiring numbers, the increased banking activities, the house price growth figures have all started to trend positively. Many of the indicators have even broken records of growth that have been set for more than five years now. The situation surely indicates that the mood among the average British citizen and business is not as bad as it was a year ago, if at all; it is a little too early to be euphoric, though. The governor of Bank of England must be feeling a lot relieved by these developments; it remains to be seen, however, how it will affect his decision making.