- Our view is that the Bank of England should sit tight on Thursday and keep interest rates at 0.75%. However, a 25 basis point cut to 0.50% is a real possibility. We believe there to be enough evidence of the economy showing improvement since the General Election to justify the MPC remaining in “wait and see” mode for now – especially as the Budget on 11 March looks set to deliver further stimulus.
- This follows the sharply increased public expenditure of 4.1% in real terms for 2020/21, announced in the September 2019 Spending Review.
- A significantly improved “flash” January purchasing managers survey for services and manufacturing activity, a quarterly CBI survey showing a rise in manufacturing optimism and improved investment intentions, reports and signs of housing market interest picking up, and surveys showing a rise in consumer confidence seem to us to be reason enough for the Bank of England to sit tight on Thursday. Additionally, there has been encouraging hard data showing that employment jumped 208,000 in the three months to November. Admittedly, the January CBI distributive trades survey remained flat, suggesting that higher consumer confidence may not have had an initial marked impact on spending.
- If the Bank of England does not cut interest rates on Thursday, we suspect the likelihood of a reduction this year will recede as we expect economic activity to become healthier.
- Consequently, we believe that it is more likely than not that interest rates will remain at 0.75% through 2020.
- We expect the Bank of England to start edging interest rates up around mid-2021. This is based on the expectation that growth will be firmer around 1.7%, the labour market will see modest improvement and inflation will reach 2.0% during the year.
Howard Archer, chief economic advisor to the EY ITEM Club, comments:
“The December MPC meeting (held on 18 December 2019) saw a second successive split within the committee regarding keeping interest rates at 0.75%. Michael Saunders and Jonathan Haskel argued that an immediate 25 basis cut to 0.50% was justified given the economy’s recent soft performance, modest but rising spare capacity, slowing employment growth, subdued core inflation and downside risks to the outlook from the global economy and Brexit uncertainties - all warranting extra stimulus now to see a sustained return by inflation to its 2.0% target.
“The other seven MPC members were in “wait and see” mode, taking the view that interest rates of 0.75% currently remain appropriate as UK data had recently been broadly in line with expectations and that it was too soon to judge how the economy would be affected by the General Election result, as well as some signs of global growth stabilising and some de-escalation of US–China trade tensions. With regards to the Conservatives gaining a clear majority in the general election, the Bank of England observed “There is no evidence yet about the extent to which policy uncertainties among companies and households have declined.”
“The minutes indicated that the other seven MPC members would be prepared to cut interest rates if downside risks materialised – noting that if Brexit uncertainties become entrenched or global growth fails to stabilise, monetary policy may need to reinforce the expected recovery in UK growth and inflation.
“The MPC considered that the outlook for GDP growth in the first half of 2020 would “depend significantly on how uncertainty evolved”. For the time being, the MPC maintained the view that growth would pick up from early 2020 due to easing in Brexit uncertainty, higher government spending and an improving global economic outlook. While the Bank of England expects consumer price inflation (1.3% in December) to be around 1.25% by spring due to temporary effects relating to regulated energy and water prices, as well as sterling’s recent strengthening, the MPC maintained the view that it would rise slightly above its 2% target by the end of the forecast horizon.
“The MPC maintained the view that if the UK economy develops in line with the Bank of England’s November projections, some modest tightening of monetary policy might be needed to maintain inflation sustainably at its target rate. The MPC had originally switched to this view at their November meeting which had represented a dilution of their previous expectation that interest rates would need to rise over the medium term. Up until November and for an extended period, the MPC’s mantra had been that if there is a “smooth” UK departure from the EU, the UK would likely need a gradual and limited increase in interest rates to sustainably meet its 2.0% inflation target. This also assumed some recovery in global growth.
Three MPC members indicate they could vote for a cut
“Three of the MPC members who voted for unchanged interest rates in December (Mark Carney, Gertjan Vlieghe and Silvana Tenreyro) all stated in early January that they could vote for a rate cut in the near term if the economy fails to quickly show clear signs of picking up after December’s decisive General Election result.
“Meanwhile, consumer price inflation falling to a 37-month low of 1.3% in December (well below the Bank of England’s 2.0% target rate) provides the MPC with ample scope to act.
Bank of England can and should sit tight on interest rates on Thursday
“We believe that interest rates should remain at 0.75% on Thursday – and likely beyond – given that the economy looks well-positioned to pick up early on this year, fiscal stimulus is on the way and the labour market also looks strong.
“The near-term outlook for the UK economy has improved with the reduced uncertainties following the decisive General Election result likely to trigger some business investment and projects that had been delayed during 2019. Consumers may also be more prepared to step up their discretionary spending.
“Admittedly, most of the evidence relates to surveys and confidence and it remains to be seen to what extent this translates into stronger activity – and if it is sustained. But it does look relatively encouraging overall so far.
“The more upbeat economic news includes a significantly improved “flash” January purchasing managers survey for services and manufacturing activity (showing overall output growth at a 16-month high with new orders expanding the fastest since September 2018 and confidence at the highest level since July 2015), a quarterly CBI survey showing a marked rise in manufacturing optimism and improved investment intentions, reports and signs of housing market interest picking up and surveys showing a rise in consumer confidence. Admittedly the January CBI distributive trades survey suggested that higher consumer confidence may not have had an initial marked impact on spending as its sales balance was unchanged from December and flat, although the January/December readings were the highest since last April.
“Additionally, there has been encouraging hard data showing that employment jumped 208,000 in the three months to November.
“Meanwhile, further fiscal stimulus is expected in the Chancellor’s Budget on 11 March.”