Bank of England stimulus supports UK energy prices

All nine members of the Monetary Policy Committee voted in favour of a cut in the interest rate from 0.5% to 0.25%. The new rate is a record low and the first change since 2009 when the rate was cut from 5.75% in the wake of the financial crisis. The Bank of England also announced a fresh round of Quantitative Easing in the form of a £70bn bond buying scheme.

The cut in the interest rate was expected, and mostly priced in, by the market following the surprise move to keep it unchanged at the last MPC meeting in July. With the exception of the large drop in Sterling in the immediate aftermath of the Brexit referendum, the market has been relatively sanguine following the referendum result. This had bought the MPC and the Bank of England time to wait for the actual impacts of the Brexit vote to become apparent in the economic data before acting. Last month, Purchasing Managers Index data highlighted a sharp contraction in the manufacturing, construction and particularly services sectors. This significantly increased the likelihood of a rate cut at yesterday’s meeting.

That said, whether the Bank would employ further QE was more of an uncertainty. Earlier this week, several polls highlighted that only around half of market participants anticipated further easing in the form of QE. Some central bankers however hinted that the Bank would be playing it safe and over-deliver on stimulus measures as a message to the market.  

What has the impact on energy prices been?

Sterling shed 1.5% against the dollar yesterday following the announcement and was trading at around 1.31 late in the session, considerably higher than the lows seen of 1.28 seen roughly a week after the referendum outcome. Back then, several large banks had anticipated sterling dropping to 1.2 against the dollar with the expected slowdown in the UK economy amid Brexit. This view is starting to appear a little overly pessimistic. The measures announced resulted in a jump in UK stocks, providing a stronger outlook for the UK economy which appeared to help offset some of yesterday’s decision’s impact on sterling. Consequently, the relatively limited drop in sterling only supported forward gas prices by approximately 1% and power by almost 2% yesterday — much of this increase has been reversed today.

What next?

We can expect further volatility from exchange rates over the coming months. The Bank of England hinted at additional stimulus if it is needed to prop up the economy if things deteriorate further. If and when this happens will of course depend on what the economic data released over the coming months tells us. 

Monetary policy in the US will also be a key driver. A stronger dollar will increase the cost of coal which has been a key driver of forward UK power contracts of late — a rising dollar however would also weigh on the price of crude oil to offset some of this impact. The Federal Reserve decided keep interest rates unchanged at last month’s Federal Open Market Committee meeting, but announced that it remains committed to a second interest rate rise later this year. This would likely push up value of the dollar significantly as the US is the only large economy currently considering increasing interest rates. This could be done as early as September. Thereafter the build up to the US election in early November is also likely to move the dollar.