- With the economy currently benefitting from the progressive easing of lockdown measures, the Chancellor announcing extra support for the economy in his July Summer Statement and with planned asset purchases currently seen sufficient to last to the end of the year, the MPC saw no need for further stimulus action at this stage
- The MPC came across as adapting a ‘wait and see’ stance on the economy and the potential need for further stimulus
- The MPC left the door open to additional stimulus further out, commenting “the Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit
- The MPC were less pessimistic about the economy in the near term, seeing a significant pick-up in activity from April’s lows, but were less upbeat about longer-term growth prospects
- In its review of appropriate monetary policy, the Bank of England concluded that negative interest rates “at this time could be less effective as a tool to stimulate the economy.” It observed that the MPC has other instruments available — for example, asset purchases and forward guidance. However, this would be kept under review
- The EY ITEM Club expects the Bank of England to announce a further dose of asset purchases – either at its September or more likely November meetings – of around £100 billion, taking the total up to £845 billion
- However, the EY ITEM Club does not expect the Bank of England will take interest rates any lower than the current level 0.10%
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“There was very little surprise in both the Bank of England deciding to keep interest rates at 0.10% or the planned stock of asset purchases at £750 billion. This was reflected in both decisions being the result of unanimous 9-0 votes within the Monetary Policy Committee (MPC).
“With the economy currently benefitting from the progressive easing of lockdown measures, the Chancellor recently announcing extra support for the economy in his Summer Statement and with planned asset purchases currently seen as sufficient to last to the end of the year, there was a strong case for the MPC to adopt a ‘wait and see’ stance on monetary policy.
“This was reflected in the minutes of the August MPC meeting, which concluded that “the Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit. The MPC will keep under review the range of actions that could be taken to deliver its objectives. The Committee does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.””
Door left open for additional further stimulus
Howard Archer continues: “Nevertheless, the minutes left the door open for additional further stimulus, noting that “although recent developments suggest a less weak starting point for the Committee’s latest projections, it is unclear how informative they are about how the economy will perform further out. The outlook for the UK and global economies remains unusually uncertain. It will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors.”
“The MPC seemed upbeat about the economy’s performance so far in the third quarter and it also observed that the Chancellor’s stimulus measures in his Summer Statement are likely to further boost consumer spending and the housing market.
“However, the MPC observed that its Regional Agents expressed concern about the demand outlook. Specifically, “There was a common fear of a large rise in unemployment, and apprehension about the possibility of a resurgence in Covid-19 cases, which might harm consumer confidence and lead to the re-imposition of restrictions on some activities. In addition, some contacts were concerned about uncertainties regarding the UK’s new trading relations with the European Union and some other countries from January 2021, and worried about possible disruption around their introduction.”
“Overall, the Bank of England came across as less confident in the UK’s recovery, considering that the economy is unlikely to regain its end-2019 size until the end of 2021. In May, it had considered that the economy would regain its fourth quarter 2019 size during the second half of 2021. The MPC observed that the Bank of England’s central projection implied that a margin of spare capacity was likely to remain until the end of next year.
“The MPC considered that risks to the growth outlook are skewed to the downside. In particular, conditions of persistent uncertainty could create strong incentives for households and companies to defer major spending decisions and focus on balance sheet resilience.
“On the jobs front, the MPC observed that employment appears to have fallen since the coronavirus outbreak, but the decline has been mitigated by the take-up of government temporary support schemes. While many workers appear to have returned from furlough schemes, the MPC considered there is considerable uncertainty about what will happen in the labour market as the support schemes unwind. The Bank considers that in the near term, the unemployment rate is likely to rise “materially to around 7.5% by the end of 2020.”
“On inflation, the MPC considered that consumer price inflation (0.6% in June) is likely to fall to around 0.25% in late-2020 and could be temporarily negative around August partly due to the VAT cut for the hospitality sector. Inflation is expected to rise gradually as temporary factors unwind and recovery in the economy sees a waning of spare capacity and an increase in domestic price pressures. Consumer price inflation is seen up to the target level of 2.0% in around two years’ time.
“The MPC observed that GDP was likely to have been some 23% lower in the second quarter of 2020 than in the fourth quarter of 2019, but higher frequency data suggest that activity has recovered significantly since the low point in April. The MPC observed that GDP was likely to have grown around 9% month-on-month in June resulting in GDP contracting 21% quarter-on-quarter in second quarter. In particular, the MPC highlighted a pick-up in consumer spending and in the housing market. However, the committee noted that business investment was likely to have fallen markedly in the second quarter and that surveys indicated that investment intentions are weak.”
Review into negative interest rates and other policy instruments
Howard Archer comments: “The Bank of England is holding a review into the case for negative interest rates and other policy instruments open to it. The Bank observed that over time the effective lower bound (ELB) for interest rates can change, noting that in the aftermath of the global financial crisis, the MPC judged that the ELB for Bank Rate was 0.5%. In 2016, it judged that the ELB had fallen to ‘close to, but a little above zero’. Those judgements were based on evidence about how any further rate cuts might be passed through to the economy at that time, and the risks they might pose to the financial sector.
“Regarding the current situation, the Bank of England observed that “At present, banks’ balance sheets will be negatively affected by the period of severe economic disruption arising from Covid-19. And they have an important role to play in helping the UK economy recover by providing finance for individuals and companies. As a result, negative policy rates at this time could be less effective as a tool to stimulate the economy. That said, the wider economy and banks’ balance sheets would be boosted by stimulus. The net effect of negative policy rates depends on these, among other, factors.”
“The Bank concluded that the MPC has other instruments available — for example, asset purchases and forward guidance. The MPC will continue to assess the appropriate monetary policy stance and will keep the appropriate tools for achieving its remit — including negative policy rates — under review.”
Bank of England issued indicative projections consistent with the MPC’s forecast
Howard Archer continues: “When releasing its Quarterly Monetary Policy Report, the Bank of England normally releases its new forecasts for the UK economy, particularly relating to GDP growth, consumer price inflation and unemployment. These forecasts are based on prevailing market expectations for interest rates.
“In the August quarterly report, the Bank of England provided indicative projections consistent with the MPC’s forecasts. These saw GDP contracting 9.5% in 2020 then growing 9% in 2021 and 3.5% in 2022.
“The unemployment rate is seen reaching 7.5% in the fourth quarter of 2020, falling back to 6% in the fourth quarter of 2021 and 4.5% in the fourth quarter of 2022
“Consumer price inflation is seen averaging 0.25% in the fourth quarter of 2020, 1.75% in the fourth quarter of 2021 and 2.0% in the fourth quarter of 2022.
“In May, the Bank had considered that a plausible scenario was for the economy to contract by 14% over 2020 then grow by 15% in 2021.”
Bank of England likely to deliver further asset purchases later this year but is unlikely to cut interest rates
Howard Archer adds: “While the EY ITEM Club expects the economy will see a clear return to growth in the third quarter, with GDP likely growing around 12% quarter-on-quarter following contraction around 20% quarter-on-quarter in the second quarter, the EY ITEM Club suspects growth is likely to slow significantly in the fourth quarter as unemployment rises.
“Furthermore, it is possible that most MPC members will maintain concerns about the longer-term outlook for the UK economy.
“Consequently, the EY ITEM Club believes the Bank of England will ultimately decide that it has a further role to play in helping the economy build a sustainable recovery amid likely still challenging and uncertain conditions. The EY ITEM Club expects the Bank of England to announce a further dose of asset purchases either at its September or (more likely) November meetings, most likely around £100 billion. This would take the total up to £845 billion.”