In a recent article where I discussed the Bank of England being at the heart of the Brexit process, I mentioned how the fall in the value of sterling following the 2016 referendum was pigeonholed by the bank as being the sole cause for inflation breaching their 2% target.
After the article was re-posted by Zero Hedge, a reader commented on something I did not make specific mention of, which was thatsix weeks after the referendum the BOE halved interest rates to 0.25%, prompting the pound to drop further in value. The reader pointed out that cutting interest rates usually results in currencies depreciating, and that the bank’s actions were the cause of a subsequent rise in inflation and not Brexit itself. Essentially, the premise here is that the BOE were responsible for devaluing the pound and creating the conditions to eventually raise interest rates a year later.
A similar comment from another reader in October last year spoke of how the BOE extending quantitative easing by £60 billion, as well as lowering rates, were ‘two sure fire things to lower the value of the pound.’
Whilst I have touched upon this in previous articles, it is a subject that deserves more attention and fresh context.
Let’s start by first going back to December 2007 when the Bank of England cut interest rates from 5.75% to 5.5%. At the time sterling was valued at $1.96. Two more rate cuts followed in February and April 2008, taking rates down to 5%. The pound remained stable around $1.97. So far the bank lowering rates had not prompted a fall in sterling.
Five months later Lehman Brothers collapsed, and so began a violent downward trend in interest rates. The next cut came in October, down to 4.5%. The chaos within financial markets had fed through to sterling – the $1.97 from five months ago was now $1.72. The BOE moved fast to keep cutting rates under the pretext of ensuring the financial system did not collapse. They trimmed rates in November to 3%, December to 2%, January 2009 to 1.5%, February to 1%, and finally in March to 0.5%.
In the space of fifteen months, rates had fallen by 5%. By the time the March cut was administered, the pound was at $1.41. For the rest of 2009, sterling traded between $1.50 and $1.70 – significantly below the high of $2.00 set on July 23rd 2008.
It should be pointed out that as the BOE were cutting rates, inflation was consistently above the bank’s 2% target for inflation. In the subsequent years following the cuts – notably from late to 2009 to late 2013 – inflation was again above remit. It reached a high of 5.1% in 2011. During this period, the high point for sterling was $1.70 set in August 2009. It otherwise traded between the...