The Governor's Weapons To Fight EU Vote Chaos

So now we know. The current level of Bank Rate, 0.5%, is not going to be the all-time low.

This time last year - even three months ago - it was almost unthinkable that the next movement in the Bank of England’s main policy rate would not be upwards. Now (NYSE: DNOW - news) , as the governor, Mark Carney, made clear on Thursday with the words “some monetary policy easing will likely be required over the summer”, the next movement will be down.

The Bank’s Monetary Policy Committee is likely to reduce Bank Rate to 0.25% on 4 August although it is possible the move may come as early as 14 July.

Yet cutting Bank Rate is only one of the policy tools at the Bank’s disposal.

Another option is to resume the Bank’s asset purchases, sometimes referred to as ‘Quantitative Easing’.

In the aftermath of the financial crisis, the Bank created electronic money and used it to buy £375bn worth of UK government bonds, or gilts. The aim of doing this was to put money directly into the previous owners of those assets, such as pension funds and insurance companies, which could then be invested in other assets such as shares and commercial property.

Economists have argued for years about the effectiveness of QE but the Bank has always insisted it was the right thing to do following the crisis. Senior (Other OTC: SNIRF - news) figures at Threadneedle Street have always made clear that the question should not be whether QE works or not but how bad things could have got, following the crisis, had it not been deployed.

It is by no means certain that the further monetary easing to which Mr Carney refers could include another bout of QE. But a number of City economists expect the Bank’s asset purchase scheme to be extended by a further £50bn - taking the total to £425bn and well over a third of all gilt issuance.

QE is not all positive for the UK economy. Wading into the market in such magnitude pushes up the price of gilts and, in so doing, depresses gilt yields – the rate of interest paid on them. This effectively reduces the Government’s cost of borrowing but also has the malign effect of widening pension fund deficits because gilt yields are the basis on which these are calculated.

The lower the gilt yield, the higher the deficit. So ironically, rather than pumping more money into the economy, QE could actually have the effect of forcing companies to divert money away from investing in productive activity and into plugging their widening pension deficits.

Mr Carney’s announcement has already pushed down the yield on some gilts – the two-year duration – to such an extent that, for the first time, they have gone negative.

In other words, as with countries like Germany, Austria, the Netherlands, Japan and Switzerland, investors are now effectively paying the UK government for the right to lend it money.

There are other monetary tools at Mr Carney’s disposal. One that City economists suspect might be deployed is an expansion of the Bank’s ‘Funding for Lending’ scheme, (FLS) launched in July 2012, under which commercial banks and building societies are given access to cheap loans from the Bank for them to lend to customers in the so-called ‘real economy’.

To date, some £58bn has been made available to the banks under FLS, with Lloyds Banking Group (Other OTC: LLOBF - news) , owner of the UK’s biggest mortgage lender Halifax, the biggest single user of the scheme. FLS is generally regarded as having been a success since its launch – indeed, Mario Draghi, the president of the European Central Bank, has launched a scheme modelled on it to try and boost growth in the Eurozone but its success going forward will depend very much on whether households and businesses are in the mood to spend the extra money made available.

This has to be debatable as there are already signs that consumer confidence has taken a hit since the shock referendum result.

Aside from monetary tools, Mr Carney has also been stressing the financial policies that the Bank has been using to promote financial stability, including the stress tests it has been using to ensure the banking system is equipped to deal with shocks. All of the banks are now better capitalised than they were in the build-up to, and aftermath of, the financial crisis.

But one extra measure that the Bank may look at now, according to analysts, could involve the removal of the so-called ‘countercyclical buffer’. This is an extra amount of capital that the banks have had to put aside in case of bad times and, in the UK, currently stands at 0.5% of a bank’s assets, in other words, its loans. However, it may be seen as too drastic a measure, since the buffer has only just been introduced and removing it might be seen as smacking of panic.

So those are the tools available to the Bank.

The second question that some have been asking is whether Mr Carney is the right person to be using them. This has arisen because Mr Carney made a number of interventions during the referendum campaign during which he warned, unequivocally, that a vote for Brexit would pose a severe shock to the UK’s economic and financial stability.

A number of pro-Brexit MPs, chiefly Jacob Rees-Mogg and the Conservative leadership candidate Andrea Leadsom, have launched highly personal attacks on the governor, with Mr Rees-Mogg suggesting the Bank had been leaned on by the Treasury, arguing that Mr Carney’s involvement in the campaign “fundamentally undermines the standing of the Bank and its appearance of independence”.

Asked about this on Thursday, amid speculation that Ms Leadsom or Mr Rees-Mogg could succeed Mr Osborne as Chancellor, Mr Carney said he had merely been doing his duty in warning of the consequences of a Brexit vote and insisted that events in the markets since the referendum result had borne out those warnings.

He added: “It would be irresponsible of me, or any of my other colleagues, to walk away from those obligations, because those are our obligations under statute".

Most people in the markets believe that, whatever his involvement in the referendum campaign, Mr Carney has acquitted himself well since the earthquake of 23 June.

There are no serious people calling for him to go and, at a time when the Prime Minister has resigned and the Chancellor of the Exchequer is widely expected to follow suit, it would be an act of madness to oblige him to do so.