Following the United Kingdom’s vote to leave the European Union, the exchange rate has fallen and the outlook for growth in the short to medium term has weakened markedly.  The fall in sterling is likely to push up on CPI inflation in the near term, hastening its return to the 2% target and probably causing it to rise above the target in the latter part of the MPC’s forecast period, before the exchange rate effect dissipates thereafter.  In the real economy, although the weaker medium-term outlook for activity largely reflects a downward revision to the economy’s supply capacity, near-term weakness in demand is likely to open up a margin of spare capacity, including an eventual rise in unemployment.  Consistent with this, recent surveys of business activity, confidence and optimism suggest that the United Kingdom is likely to see little growth in GDP in the second half of this year. 

 

These developments present a trade-off for the MPC between delivering inflation at the target and stabilising activity around potential.  The MPC’s remit requires it to explain how it has balanced that trade-off.  Given the extent of the likely weakness in demand relative to supply, the MPC judges it appropriate to provide additional stimulus to the economy, thereby reducing the amount of spare capacity at the cost of a temporary period of above-target inflation.  Not only will such action help to eliminate the degree of spare capacity over time, but because a persistent shortfall in aggregate demand would pull down on inflation in the medium term, it should also ensure that inflation does not fall back below the target beyond the forecast horizon.  Thus, in tolerating a temporary period of above-target inflation, the Committee expects the eventual return of inflation to the target to be more sustainable. [...]

 

The MPC is launching a Term Funding Scheme (TFS) that will provide funding for banks at interest rates close to Bank Rate.  This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions.  In addition, the TFS provides participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets. 

 

The expansion of the Bank of England’s asset purchase programme for UK government bonds will impart monetary stimulus by lowering the yields on securities that are used to determine the cost of borrowing for households and businesses.  It is also likely to trigger portfolio rebalancing into riskier assets by current holders of government bonds, further enhancing the supply of credit to the broader economy. [...]

 

As set out in the August Inflation Report, conditional on this package of measures, the MPC expects that by the three-year forecast horizon unemployment will have begun to fall back and that much of the economy’s spare capacity will have been re-absorbed, while inflation will be a little above the 2% target.  In those projections the cumulative growth in output is still around 2½% less at the end of the forecast period than in the MPC’s May projections.  Much of this reflects a downward revision to potential supply that monetary policy cannot offset.  However, monetary policy can provide support as the economy adjusts.  Had it not taken the action announced today, the MPC judges it likely that output would be lower, unemployment higher and slack greater throughout the forecast period, jeopardising a sustainable return of inflation to the target. 

 

[...] If the incoming data prove broadly consistent with the August Inflation Report forecast, a majority of members expect 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 MPC currently judges this bound to be close to, but a little above, zero. [...]