- As expected, the Bank of England left monetary policy unchanged at the December Monetary Policy Committee (MPC) meeting. Votes were unanimous (9-0) to keep both interest rates at 0.10% and the total stock of asset purchases at £895bn
- With the economy showing considerable resilience in the face of COVID-19 restrictions and the Bank of England increasing asset purchases by £150bn in November, there was little pressing need for further stimulus
- According to the MPC recent activity has been stronger than expected: GDP is now expected to contract a little over 1% quarter-on-quarter in Q4 2020, however, the latest restrictions have been tighter than expected and are likely to weigh down on activity in Q1 2021
- Looking ahead, the MPC considered that vaccine developments have diluted some of the downside risks to the economic outlook, while the additional fiscal measures in November’s Spending Review are expected to boost GDP by an estimated peak of over 1% during 2021-22
- The MPC stressed 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 most imminent downside risk to the economy is the possibility that the UK and EU will not agree a Free Trade Agreement (FTA) by 31 December
- The EY ITEM Club suspects that the case for further Bank of England support for the economy will wane as 2021 progresses. The EY ITEM Club believes that a UK-EU FTA will more firmly establish the UK’s recovery through 2021, helped by a wholesale vaccine roll out
- The MPC’s December minutes did not mention the case for negative interest rates. An anticipated waning need for further stimulus supports 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 beyond that
- While the EY ITEM Club would not rule out further asset purchases, these are unlikely as November’s £150bn purchases are anticipated to last through to the end of 2021
- Should the UK and EU not agree 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:
“As expected, the Bank of England left monetary policy unchanged at the December Monetary Policy Committee meeting. The MPC voted 9-0 both to keep interest rates on hold at 0.10% and the total of asset purchases at £895bn.
“It always looked odds-on that the MPC would sit tight at their December meeting given the resilience of the economy in November in the face of COVID-19 restrictions, and with the Bank having provided further support for the economy as recently as 5 November, when they announced an additional £150bn 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. The minutes note that ‘the Committee envisaged the pace of purchases would likely remain around its current level initially, with flexibility to slow the pace of purchases later.’
“The MPC also observed that the near-term outlook for the UK economy had evolved broadly as expected following their November meeting. On the positive side, the MPC considered that recent activity has been stronger than expected, despite the recent rise in COVID-19 cases and associated lockdowns. The Bank now expects GDP to contract by a little over 1% quarter-on-quarter in the fourth quarter of 2020.
“However, the MPC also observed that the restrictions on activity introduced after lockdowns have been tighter than it had assumed in its November forecast, and these are expected to weigh more on activity in 2021 Q1.
“The MPC identified a number of positive developments, including the successful trialling of some COVID-19 vaccines and plans to roll them out widely over the first half of next year. This is likely to reduce the downside risks to the economic outlook from COVID-19 which had been previously identified by the Committee.
“Meanwhile, the MPC considered that the extension of the Government’s employment support schemes was likely to limit significantly the near-term rise in unemployment, although a substantial further increase was still likely over the next few quarters.
“The MPC also considered that the additional fiscal measures announced in the Spending Review are likely to boost GDP by an estimated peak of over 1% during 2021-22.
“Nevertheless, the MPC observed that the economic outlook ‘remains unusually uncertain’, referencing both the pandemic and the future of the UK-EU trading relationship.
“On inflation, the MPC expects consumer price inflation – just 0.3% in November – to rise towards its 2% target from the spring once the temporary VAT cut for the hospitality sector ends and there are negative base effects from the fall in oil prices in early 2020.
“On the possibility that the UK and EU do not reach a trade agreement, the MPC indicated that it would ‘tolerate’ a temporary overshoot of the inflation target. The committee claimed that without a deal, the exchange rate would probably fall and, relative to the projections in the November Report, CPI inflation would likely be higher and GDP growth weaker.
“The MPC also made it clear that it is willing to take further stimulus action if necessary, while any tightening of monetary policy remains a considerable way off. The minutes noted that ‘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.’”
Bank of England still reviewing case for, and practicalities of, negative interest rates
Howard Archer continues: “There were no indications in the December MPC minutes that negative interest rates are imminent. Indeed, there were no references to negative interest rates in the minutes at all.
“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 within 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.’”