It will also purchase of up to £10bn of UK corporate bonds and has expanded its asset purchase scheme for UK government bonds to £435bn.
As reason for the decision, the BoE cited the weakness in both sterling and the short to medium-term growth outlook following June’s EU referendum.
It said the UK is likely to see little GDP growth in the second half of the year as a result of this but, at the same time, sterling weakness should push up on inflation in the short term.
“These developments present a trade-off for the MPC between delivering inflation at the target and stabilising activity around potential,” it said.
According to the Bank, given the extent of the expected demand weakness relative to supply it was willing to risk a temporary period of above-target inflation driven by currency weakness in order to ensure that over the medium term inflation returns to the target level on a more sustainable basis.
Term funding scheme
Acknowledging that the current low level of interest rates will could limit the ability of some banks to further lower lending rates, it has also implemented a term funding scheme.
This scheme, it said: “will provide funding for banks at interest rates close to Bank Rate. This monetary policy action should help reinforce the transmission of the reduction in Bank Rate to the real economy to ensure that households and firms benefit from the MPC’s actions. In addition, the TFS provides participants with a cost effective source of funding to support additional lending to the real economy, providing insurance against the risk that conditions tighten in bank funding markets.”
It also hopes that the expansion of its gilt purchasing plan will further push investors up the risk scale thereby “further enhancing the supply of credit to the broader economy”.
And, it added: “Purchases of corporate bonds could provide somewhat more stimulus than the same amount of gilt purchases. In particular, given that corporate bonds are higher-yielding instruments than government bonds, investors selling corporate debt to the Bank could be more likely to invest the money received in other corporate assets than those selling gilts.”
As a result of these measures, the BoE expects that, by the end of its current three-year forecast horizon: “employment will have begun to fall back and that much of the economy’s spare capacity will have been re-absorbed, while inflation will be a little above the 2% target.
“In those projections the cumulative growth in output is still around 2½% less at the end of the forecast period than in the MPC’s May projections. Much of this reflects a downward revision to potential supply that monetary policy cannot offset.”