Bank of England to Cut Interest Rate to 0% on Thursday: Soc Gen

- Small cut likely
- Pound to fall back on a cut
- Quantitative Easing to be expanded

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The Bank of England will cut its basic interest rate and raise its quantitative easing programme to support the lockdown-ravaged UK economy, according analysts at major pan-European lender and investment bank.

Société Générale says that much has changed since the Bank's economists released their last set of forecasts back in November, with a harsh lockdown being introduced in January materially shifting the economy's outlook for the worse.

As such, policy makers will act by increasing the stimulus they on offer to the struggling economy.

The move would likely come as a surprise to the market as the consensus view is that the Bank is willing to keep interest rates unchanged and look through current difficulties facing the economy, choosing to focus on a spring rebound in activity.

A cut would therefore likely wrong-foot the market and undermine the rally in the British Pound, potentially triggering a sharp reversal in value, as noted in our week-ahead forecast article.

"Since the last Monetary Policy Report MPC meeting in November last year, the fight against the coronavirus has faced many fresh challenges which have hurt the short-term economic outlook. The emergence of new variants and the alarming increase in the level of infections, hospitalisations, and deaths has put the NHS under increasing, massive strain," says Brian Hilliard, an economist with Société Générale.

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The February appearance of the Bank of England's rate setters coincides with the Bank's quarterly inflation report, where new forecasts are issued.

It is usually at these higher-profile meetings that the Bank opts to make changes to interest rates and quantitative easing, meaning February's report will garner more attention from markets than is normally the case.

November's MPR took account of the November 2020 lockdown but Hilliard says this report was too optimistic about the level of lockdown necessary in the first quarter of 2021.

"The result is that the MPC is likely to make a significant downgrade to its GDP forecast for this year from the current 7¼% to closer to 5%," says Hilliard.

Consequently, Société Générale expect the Monetary Policy Committee to ease policy again in February and announce a boost to the existing quantitative easing programme by £150BN.

But Thursday's MPC and MPR event will also see the Bank report back on the findings of a review into whether negative interest rates would be feasible in the UK.

The Bank's Prudential Regulation Authority initiated a review into the matter last October, and their findings will likely determine whether a cut to 0% or below is possible without negatively impacting the country's financial services sector.

"The review of negative interest rate policy is likely to have been finished. We think the committee will say that such a policy is feasible and worth doing because it would provide a meaningful stimulus," says Hilliard.

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In a speech delivered in January, MPC member Silvana Tenreyro said she believed negative interest rates would be a positive development that can further aid the under-pressure UK economy.

However, other members of the MPC, including Governor Andrew Bailey, said in January it was too soon to consider cutting interest rates, even if it were an option worth considering over coming months.

But, Société Générale are of the opinion the Bank will want to maintain a proactive approach to policy and will deliver a small cut. They cite the argument of MPC member Michael Saunders that any further rate cuts should be done in smaller increments than the standard 25bp, to maintain a realistic expectation in the markets that further cuts would be possible.

"On this basis, we expect the easing package to include a cut in Bank Rate to precisely zero, accompanied by an expansion of the Term Funding Scheme (possibly following the tiering approach of the ECB TLTRO) to mitigate the impact of the cut on banking profitability," says Hilliard.

The market is currently not expecting an interest rate rate cut to occur, making the Société Générale view one that falls outside of consensus.

If their view is however proven correct Pound Sterling would likely fall, given markets are expecting rates to remain unchanged.

"Sterling could suffer if the Bank of England unexpectedly cuts interest rates by 10 basis points to zero next week," says Robert Howard, a Reuters market analyst.