Yesterday, the Bank of England cut its interest rate and introduced a package of measures designed to provide additional monetary stimulus. What does it imply for the gold market?
As expected, the BoE cut the Bank Rate from 0.50 to 0.25 percent, a new historic low. It was the first cut since 2009, motivated by the reduction of the BoE’s GDP forecast for 2017 from 2.3 to just 0.8 percent after the Brexit vote. The funny thing is that the Bank of England, together with the Fed, belonged to the elite club of relatively hawkish central banks considering interest rate hikes. It’s all gone – now the Fed is the only major central bank which would like to normalize its monetary stance.
If you are afraid that 0.25 percent is too high a level for interest rates, don’t worry – the Monetary Policy Committee (the English counterpart of the FOMC) signaled that it was likely to vote for further cuts towards zero this year. It goes without saying that gold likes the environment of low interest rates.
The additional monetary stimulus includes:
- A £60-billion increase in the stock of purchased UK government bonds over six months, which would put total purchases at £435 billion. The motivation is to lower the cost of borrowing for households and companies and to trigger portfolio rebalancing into other assets by the sellers of gilts. We doubt the effectiveness of QE for the real economy, but it may boost financial markets, at the expense of gold.
- Purchases of corporate bonds up to £10 billion over 18 months. The aim is to lower the yields and reduce the liquidity premium. Why do central banks not purchase gold under their monetary stimulus programs?
- A Term Funding Scheme worth £100bn to reinforce the pass-through of the cut in the Bank Rate. The idea is to provide funding for banks at interest rates close to Bank Rate to encourage them to reduce deposit rates further. If this scheme really reinforces monetary transmission, it should be rather negative for gold market, as it would revive the credit expansion and confidence in the monetary policy.
The key takeaway is that the BoE’s interest rate cut and additional measures undertaken to stimulate the economy signal a deepening in the current divergences between monetary policies of major currency areas. It is good news for the gold market, as the Fed may find it even harder to hike as its recent ally decided to loosen. Indeed, the market odds of a hawkish Fed move this year declined after the BoE’s decision. In consequence, the price of gold also rose yesterday, even as the U.S. dollar climbed. This is because the BoE cut added up to the global low or negative interest rate environment and signaled that the consequences of Brexit could be underestimated by many analysts – both factors are supportive for gold. Anyway, traders await the non-farm payrolls data. Stay tuned!
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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.
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Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor
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