×

Turning it up to 11: Why the BOE is like Spinal Tap

Monetary stimulus is meant to be economic Viagra administered to cure flaccid performance. But just like the introduction of the small blue pill, size, timing and judgement of outcomes are critical. Sometimes, of course, a little help may not be necessary at all.

That doesn't apply in the case of the U.K. economy of course, and it appears the BOE is not taking any chances on sub-par performance.

Thursday's announcement goes significantly beyond expectations and reveals a degree of fear about the direction of the economy that will take markets by surprise. In the biggest revision to the growth outlook since 1993, the bank has slashed gross domestic product to 0.8 percent next year, and said that will only be achieved as a result of the measures taken by the BOE today: A cut in rates; a Term Funding Scheme to protect bank margins; and £70 billion ($92 billion) of bond buying.


Turning it up to 11

The Bank of England, London
Simon Dawson | Bloomberg | Getty Images
The Bank of England, London

And just in case there is any misunderstanding about the bank's desire to address weaker property investment, or lower business or retail spending, the Monetary Policy Committee has used forward guidance to suggest there is more to come. The bank has signalled that interest rates are likely to be cut again before the end of the year to close to zero percent. This is about as near to shock and awe as central banking gets.

In one of my favourite movies, "This is Spinal Tap," there is a discussion about renumbering the dials on the amplifier to get to 11. This supposedly makes it louder and more powerful than any other amplifier. The bank has just taken us to that mythical 11!

And therein lies the dilemma for the Bank of England at this meeting. A couple of recent business surveys have revealed a post-Brexit drop in confidence but the U.K. economy was not exactly flat on its back ahead of the vote. Second-quarter gross domestic product (GDP) surprised to the upside at 0.6 percent and inflation is running at 0.5 percent. That is some way off the BOE's 2 percent target but firmer than we've seen in recent years. In fact employment growth, bank lending and inflation have all been trending in the right direction. Was it really necessary then to deliver this much stimulus today?

The projections in the statement are gloomy. The bank does see a quicker pick up in inflation due to the weakness in sterling, but not enough of a problem to stay its hand. Clearly of more concern is the projected cumulative 2.5% reduction in growth now expected over the 3 year forecasting period. As a result of that unemployment is seen edging back towards 6 percent.

Of course, not all performance enhancers are welcome. Look what problems they've created for the Russian Olympic team in Rio. Inappropriate use of stimulants can have the opposite effect to the one intended and over the longer term, can be damaging to health.

And, of course, the joke in Spinal Tap is that the loudness hasn't actually changed even though the numbers have gone up.

The Bank of Japan and the European Central Bank can attest to the diminishing returns monetary activism appears to be having on final demand. Will a quarter-point cut in base rates and more bond-buying stimulate economic activity or merely drive the prices of financial assets higher whilst reducing returns for prudent savers?

And markets might begin to question the signalling function of Thursday's announcement as it relates to fiscal policy. Prime Minister Theresa May's new government appears to have ripped up the deficit reduction plans of former Chancellor George Osborne which shaped the BOE's lowered growth projections in May. If the new Chancellor Philip Hammond and Governor Carney talk does that mean that there will be less fiscal stimulus in the Autumn Budget than now expected?

Today's package of measures will probably be welcomed by those who are short sterling and long stocks, but, in the round, it raises more worrying questions about the U.K. growth outlook. If the bank's projections come to fruition, it implies more action may be required than a further 15 basis point cut in rates.

And that's the problem with stimulants. As any athlete will tell you, that's the challenge with performance enhancers - once you start down that road it's very hard to stop!

Geoff Cutmore is co-anchor for CNBC's flagship programme Squawk Box in EMEA. You can follow him on Twitter @geoffcutmore


Follow CNBC International on Twitter and Facebook.