BOE cuts Rates

It could have larger implications for the world economy…

The Bank of England (BOE) cutting rates was never a question of whether, but when. It was clear that post-BREXIT there would be pressure on the British central bank to propel the economy with monetary support. Infusing liquidity is the easiest and most impactful measures of pumping up the economy. But the implications of the BOE rate cut could actual stretch much beyond UK. Here are 3 key impact areas…

US Fed may put off rate hikes

 In the last Fed review in July, Janet Yellen had clearly indicated that the halt on rate hikes would be temporary as the US economy had started showing green-shoots of recovery. With the BOE clearly adopting a loose money policy, the US Fed may be actually impelled to back-end rate hikes much beyond 2016. The big risk that the US sees is monetary divergence. UK had been one of the better performing economies in the European region. Post BREXIT, the GDP growth of England has been downgraded from 2.3% to 0.8%. For a $3 trillion economy, that could mean a substantial cut in demand, wages and jobs. The US would not be too keen to upset the applecart by hiking rates as that would mean greater monetary divergence and therefore greater volatility in global financial markets. Most likely, the US Fed may choose to put off rate hikes well beyond 2016 and probably consider rate hikes only around mid-2017, if at all.

Pressure on commodity prices

 The cut in interest rates by the BOE betrays a clear signal of growth desperation. If the UK economy falters, then the EU economy cannot be too far behind. Let us not forget that the EU is one of the major net importers and consumers of oil. A slowdown in both these regions will not only have repercussions on demand for oil but also shrink trade for leading global economies like the US, Canada, Japan and China. For most of these large economies the trade shrinkage may continue if the UK and the European economies show distinct signs of slowing down. Oil prices have already fallen below the $45/bbl mark.

Emerging markets may benefit

While a slowdown in UK and Europe will surely impact trade, EMs will benefit in terms of capital flows. This rate cut will further accentuate the negative yield scenario across Europe and Japan leading to greater risk-on flows. The big beneficiary will be countries like India which offer the best combination of high yields and a stable currency. The impact of the BOE rate cut is already visible in FPI flows into India. After infusing $3 billion into Indian equity and debt markets in July, the FPIs continue to be aggressive buyers in August. Global investors may have decisively turned risk-on and Indian markets surely have reasons to celebrate! ©

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