- The EY ITEM Club expects limited fireworks from the Bank of England on 5 November as negative interest rates appear to be off the table, although a further £100bn of asset purchases are very likely to be announced
- At its September meeting, the MPC appeared to be in ‘wait and see’ mode, and willing to deliver further economic stimulus if needed
- Even before the announcement of the new national lockdown for England, it had looked highly likely that the Bank of England would provide more support for the economy amid signs that activity and confidence were being affected by rising COVID-19 cases and increased restrictions. The potential of markedly rising unemployment and ongoing uncertainty about the future UK-EU relationship are further serious downside risks to the outlook
- With the new national lockdown, it is inevitable that the Bank of England will downgrade its outlook for the UK economy compared to its August expectations, and put back its anticipated timing of when the economy will regain its Q4 2019 level (from the end of 2021)
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“The Bank of England looks poised to provide a spark for the UK economy on 5 November by enacting a further £100 billion of asset purchases, which would take the total up to £845 billion.
“However, the EY ITEM Club expects the Bank will hold off from the more significant action of taking interest rates into negative territory and will keep them at 0.10%. The EY ITEM Club expects both decisions to be the result of unanimous 9-0 Monetary Policy Committee (MPC) votes.
“In its September meeting, the MPC came across as being very much in ‘wait and see’ mode and willing to act if, and as soon as, necessary. This reflected their view that the outlook for the UK economy “remains unusually uncertain.” The minutes of the September meeting concluded that the “Committee would continue to monitor the situation closely and stood ready to adjust monetary policy accordingly to meet its remit.”
Howard Archer continues: “Some of the downside risks facing the UK economy that had concerned the MPC at their September meeting have already materialized.
"Even before the announcement of the new national lockdown in England from Thursday, it was evident that local restrictions had been having an impact on the economy. Consumer confidence declined in October when the CBI distributive trades survey showed an appreciable weakening in retail sales. Additionally, the October purchasing managers’ surveys showed a loss of momentum in manufacturing and, especially, services activity.
“These signs of softening economic activity and the heightened downside risks to the outlook coming from increasing COVID-19 cases add to the possibility that unemployment will rise markedly when the furlough scheme comes to an end (now at the end of November). While the Government has reacted by providing more comprehensive job support measures, it still looks more likely than not that unemployment will pick up appreciably.
“Meanwhile, a further significant downside risk to the economy comes from the possibility that the UK and the EU could fail to conclude a free trade agreement by 31 December when the transition period ends.
“Consequently, even before the new lockdown announcement, a number of MPC members had recently expressed serious concern at the increased downside risks and uncertainties facing the UK economy, notwithstanding its robust third quarter bounce back from the record second quarter contraction.
“The Bank of England Governor Andrew Bailey stated that the risks facing the UK economy are “very heavily skewed” to the downside as it faces “unprecedented” uncertainties that have been heightened by rising COVID-19 cases. Bailey notably observed that the best approach on monetary policy was to act aggressively rather than cautiously in the face of uncertainty.
"It therefore seems very likely that the Bank of England will downgrade its outlook for the UK economy in terms of when it expects it to grow to the level of the fourth quarter of 2019. In its August Quarterly Monetary Policy Report, the Bank provided indicative projections which saw GDP contracting 9.5% in 2020 then growing 9% in 2021 and 3.5% in 2022. This meant that the economy was expected to regain its fourth quarter 2019 level at the end of 2021.
“It now looks highly probable that the UK economy will contract by well over 10% in 2020 given the imminent national lockdown in England. The pre-lockdown announcement consensus forecast was for growth in 2021 of around 6% which now looks likely to come down amid the increasing downside risks to the outlook.”
Bank of England still reviewing case for, and practicalities of, negative interest rates
Howard Archer continues: “While there is a compelling case for further Bank of England stimulus to be enacted on Thursday to support the economy, a move to negative interest rates will almost certainly not occur – at least for now.
“It is clear the Bank of England is not yet finished with its review of the case for negative interest rates and the practicalities of introducing them. The Prudential Regulation Authority (PRA) contacted commercial banks on 11 October requesting information on their operational readiness for a zero or negative Bank Rate and gave them until 12 November to respond. This suggests that a move to negative interest rates will not happen as soon as Thursday. The Governor also stressed that the fact that banks were being asked about their operational readiness for negative interest rates should not be taken as a sign that they will be introduced.
“Meanwhile, opinion seems to be split between the MPC as to whether negative interest rates would be in the best interests of the UK economy. There have been cautiously positive comments made about negative interest rates from some MPC members, mainly with regard to their positive impact on boosting bank lending in other countries, although there is acknowledgement that the effectiveness of a negative interest rate is probably going to be contingent on the structure of the financial system.
“However, other MPC members have expressed doubts about negative interest rates, with Deputy Governor Dave Ramsden saying that they risk damaging UK banks’ capacity to lend and chief economist Andy Haldane observing that none of the conditions that would justify taking interest rates negative have been met.
“Meanwhile, the Bank of England Governor has observed that “Our assessment of negative interest rates, from the experience elsewhere, is that they probably appear to work better in a more wholesale financial market context, and probably better in a nascent economic upturn.””