- As long as there is a not a complete breakdown in UK-EU trade talks on Sunday, it is more than likely that the Committee will sit tight on providing further monetary stimulus at the final Bank of England Monetary Policy Committee (MPC) meeting of the year
- With the economy seemingly showing considerable resilience in the face of the latest English lockdown and other restrictions, the Bank of England seems unlikely to act in the near term at least
- The MPC will undoubtedly stress that there are significant uncertainties and challenges that continue to face the UK economy and that they are ready and willing to take further supportive action if necessary
- The EY ITEM Club suspects that the case for further Bank of England support for the economy will wane as 2021 progresses
- Positive developments on COVID-19 vaccines should dilute some of e the downside risks to the outlook. Providing a UK-EU Free Trade Agreement (FTA) is also secured, the EY ITEM Club believes that the UK’s recovery will become more firmly established through 2021
- The Bank of England is still reviewing the case for negative interest rates, but the anticipated waning need for further stimulus fuels the EY ITEM Club’s belief that they are unlikely to be adopted
- Interest rates are expected to remain at 0.10% throughout 2021 and most likely much longer than that
- Should the UK and EU ultimately fail to come to a deal on an FTA, the EY ITEM Club believes the Bank of England would be likely to respond with more stimulus to support the economy. This almost certainly would involve more asset purchases. In addition, a move to negative interest rates would become more likely
Howard Archer, chief economic advisor to the EY ITEM Club, says:
"The Bank of England looks highly unlikely to be handing out any early Christmas presents to the UK economy in the form of further stimulus on 17 December after the final Monetary Policy Committee (MPC) meeting of 2020.
"We suspect that the December meeting will see the MPC vote 9-0 both to keep interest rates on hold at 0.10% and the total of asset purchases at £895 billion. This would at least mark an uneventful end to what has been a hugely challenging year for the Bank of England. As part of its efforts to support the UK economy against the impact of COVID-19, the Bank of England has taken interest rates down from 0.75% to a record low of 0.10% and is reviewing the case for negative interest rates. In addition, the Bank announced asset purchases amounting to £450 billion, taking the total up to £895 billion.
"The Bank of England provided further support for the economy on 5 November, when it announced an additional £150 billion of asset purchases. The Bank of England indicated that the new asset purchases would start in January and last through to the end of 2021. Specifically, the November meeting minutes reported that: “the Committee envisaged that the pace of purchases could remain at around its current level initially, with flexibility to slow the pace of purchases later. Should market functioning worsen materially again, however, the Bank of England stood ready to increase the pace of purchases to ensure the effective transmission of monetary policy.”
“The MPC acted in November amid concerns that downside risks to the UK economy were materialising, most notably rising COVID-19 cases resulting in a national lockdown in England. Furthermore, there had been clear signs that the economy had lost momentum in October as some restrictions on activity had been imposed. Indeed, the minutes of the November MPC meeting noted there were signs that consumer spending had softened while investment intentions remained weak. With COVID-19-related restrictions expected to weigh on activity, the Bank of England consequently saw GDP contracting in the fourth quarter. While the Bank of England expected consumer spending and GDP to pick up in Q1 2021 as restrictions on activity are eased, it still saw GDP in Q1 2021 around 9% lower than the level in Q4 2019.
“The Bank of England stressed in November that the economic outlook remains “unusually” uncertain observing that “It depended on the evolution of the pandemic and measures taken to protect public health, as well as the nature of, and transition to, the new trading arrangements between the European Union and the United Kingdom. It also depended on the responses of households, businesses and financial markets to these developments.”
“The MPC made it clear at their November meeting that they are willing to take further stimulative action if necessary, while any tightening of monetary policy remains a considerable way off. Specifically, the minutes commented: “The MPC will continue to monitor the situation closely. If the outlook for inflation weakens, the Committee stands ready to take whatever additional action is necessary to achieve its remit. The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.””
Events since November MPC meeting do not call for further stimulus
Howard Archer adds: “Having provided more monetary stimulus in November and with the economy seemingly showing considerable resilience in the face of the recent English lockdown and other restrictions, it is unlikely the Bank of England will act in the near term at least.
“The economy seems to have shown considerable resilience in the face of the latest lockdown and other restrictions. Survey evidence from the purchasing managers points to manufacturing and construction activity continuing to expand in November, while overall contraction in services activity appears to have been limited with the weakness mainly in the hospitality, leisure and tourism sectors. Retail sales were clearly impacted, but online sales took up some of the slack.
“The English lockdown duly ended on 2 December and there has been an overall easing of restrictions on activity, although they do currently remain appreciable overall with most areas in the UK placed at the higher end of the three-tier system that is now in place.
“Meanwhile, there have been substantial positive developments on the COVID-19 vaccine front since the MPC last met, with the first vaccinations in the UK occurring on 8 December. Obviously, there is a long way to go, but the significant recent progress concerning the vaccine does seemingly have positive implications for the economy.
“Of course, the current big near-term unknown is what will happen with the UK-EU trade negotiations over the coming days. A breakdown of negotiations over the coming days would substantially change the economic outlook and environment for monetary policy.”
Bank of England still reviewing case for, and practicalities of, negative interest rates
Howard Archer continues: “There were no mentions in the minutes of the November MPC meeting or in the Quarterly Monetary Policy of the possibility of negative interest rates.
“The Bank of England is not yet finished with its review of the case for negative interest rates and the practicalities of introducing them.
“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, 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, saying that they risk damaging UK banks’ capacity to lend and observing that none of the conditions that would justify taking interest rates negative have been met.
“Meanwhile, the Bank of England Governor has observed: “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.””