The Bank of England’s Cut Will Affect the Fed’s September Decision

The Bank of England’s Cut Will Affect the Fed’s September Decision

The Bank of England’s monetary policy easing has added to market expectations that the FOMC will remain sided-lined through the rest of the year. Implied Fed funds are now suggesting only about 18% risk for a tightening next month. That’s down about 10 percentage points from late July after the somewhat upbeat FOMC policy statement. Risk for a hike by year end has dipped to about 35% from 45% late last month too. The impending October 14 deadline on money market reforms, as well as the November 8 presidential election are key factors that will limit Fed action at the September 20, 21, and November 1, 2 FOMC meetings. Growth and inflation should have risen enough by the December 13, 14 policy meeting to enable the Fed to get back on the normalization path.

The Bank of England cut its repo rate by 25 basis points for the first time in 9-years.  During its July meeting the central bank kicked the can down the road, but were relatively clear that they had planned on cutting rates at their August MPC.  So the markets largely priced in an interest rate cut, and short and long term UK yields as well as the pound had priced this change into financial instruments via online trading.

The markets were caught off guard by the check raise scenario that the BoE’s Carney pulled. For those of you that don’t play poker, a check raise, is used when you have a relatively good hand.  The first time around you check, allowing others to take stock of the pot. When betting returns, you raise, taking the rest of the players by surprise.  This is what Carney seemed to do today.  Not only did the central bank head reduced the repo rate, which is the bench mark interest rate, he also was preemptive, by increasing the bond purchase program for the first time in 7-years.

purchase program

The quantitative easing program was expanded by increasing the notional amount by 70 billion pounds to 445 billion pounds. The majority of the bonds that will be purchased are government bonds, gilts, but 10 billion pounds will be allocated toward purchases of corporate bonds.  Corporate bond purchases will directly impact businesses as they will be able to borrow funds at a cheaper rate.

The pound sold off immediately and the reduction in the rate paid to hold the pound will make the currency less attractive.  A cheaper currency will make exporting goods and services more attractive as it will be less expensive to purchase UK goods.

The BoE was startled by the immediate decline in UK economic data.  Sentiment tumbled and the BoE decided they needed to get in front of the curve to reduce the likelihood of the UK economy going into a recession.

With the Bank of England, European Central Bank and Bank of Japan in the midst of robust monetary stimulus it will be very difficult for the Federal Reserve to continue its path of normalization by raising interest rates in September or December.