In a surprise to financial markets, the Bank of England kept interest rate unchanged. Yahoo Finance reached out to Mohamed A. El-Erian for his reaction.
by Mohamed El-Erian
With the outcome of the Brexit referendum likely to slow UK growth and make the economy more vulnerable to a recession, the Bank of England signaled a couple of weeks ago its intention to cut interest rates this summer. Accordingly, most market participants expected a 25 basis points reduction today, with some even suggesting that the central bank could opt for a 50 basis points cut to 0% for the benchmark rate.
In what constitutes a very unusual move for western central banks in recent years, Bank of England officials went against market expectations and kept interest rate unchanged. (The exact split of the Monetary Policy Committee was 8 members for staying put on rates against 1). The MPC did signal a notable probability of a cut in its next meeting in August given that it still expects UK growth to be negatively impacted by Brexit. But this signal was not enough to avoid a significant immediate strengthening of the currency on the back of what is now perceived to be a tighter monetary policy than had been previously expected.
It is not clear as yet why UK central bankers decided to wait. I suspect that at least three factors may have played a role.
First, the post-referendum market disruptions have proven relatively limited in time, scale and scope. Accordingly, central bankers would be less worried about the possibility that financial market losses – in themselves – would lead to lower growth. As such, they may feel they have more time for a comprehensive assessment of the possible denouement of negative wealth effects and dampened consumer/corporate sentiment.
Second, the new UK government has signaled that it is in no rush to trigger Article 50. Instead, it is set on taking its time to negotiate an orderly exit from the European Union. That delays the immediate disruptive economic effects of a new set of UK trading arrangements with Europe.
Third, Bank of England officials are aware of the tricky trade-off that excessive reliance on central banks has entailed in recent years – that is, the possibility of short-term economic stimulus versus the mounting risk of financial instability down the road.
In simple terms, the Bank of England decided to maintain maximum policy optionality for at least a month pending a fuller assessment of post-referendum economic developments and prospects. In doing so it also signaled that, among the big three western central banks (the Federal Reserve, the European Central Bank and the Bank of England), there is at least one institution that is willing to go against consensus market expectations.
Mohamed A. El-Erian is the chief economic advisor to Allianz, the corporate parent of PIMCO where he served as CEO and co-CIO (2007-2014). He is Chair of President Obama’s Global Development Council and the author of two New York Times Best Sellers: the 2008 “When Markets Collide” and this year’s “The Only Game in Town.”