- While there is a case for the Bank of England to provide more stimulus for the UK economy at the February Monetary Policy Committee (MPC) meeting, the EY ITEM Club believes that it is more likely that the MPC will leave both interest rates (0.10%) and the asset purchases target (£895bn) unchanged.
- Although the EY ITEM Club would not rule out Bank of England action on Thursday, it predicts that the MPC will look beyond a challenging Q1 and focus on the economy’s brighter longer-term prospects: the vaccine roll-out may facilitate an easing of restrictions from Q2 and hopefully pave the way for firming growth.
- The relative resilience of the labour market so far should also provide reassurance to the Bank of England. In addition, the UK-EU Free Trade Agreement has removed a downside risk to growth. Ongoing fiscal stimulus for the economy further eases pressure for more Bank of England support.
- The EY ITEM Club suspects that the case for further Bank of England support for the economy will wane from Q2 as the recovery takes hold.
- Consequently, the EY ITEM Club believes that the Bank of England is most likely to hold off from acting through 2021, keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn. This would be in clear contrast to the highly active year the Bank had in 2020.
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“The UK is facing a challenging start to 2021 and there are signs that the economy will be more affected by the first quarter’s lockdowns and restrictions than it was by the fourth quarter 2020’s restrictions. The economy appears headed for clear contraction in the first quarter after likely avoiding a decline in the fourth quarter of 2020. Furthermore, the current lockdowns and restrictions look highly likely to last through the current quarter.
“Nevertheless, the EY ITEM Club believes that the Bank of England’s Monetary Policy Committee (MPC) is most likely to hold off from taking further stimulus action to support the economy next Thursday following their February meeting.
“While it is possible that some MPC members could take the view that extra support for the economy is warranted by the current heightened pressures, the EY ITEM Club believes it is most likely that there will be unanimous 9-0 votes for keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn.
“The EY ITEM Club suspects that the MPC will look beyond the admittedly challenging first quarter facing the UK economy and focus more on the brighter longer-term prospects. The progressive roll-out of the COVID-19 vaccines should facilitate the easing of restrictions and opening up of the economy from Q2, paving the way for firming growth.
“Consumers look well-placed overall to play a key role given the recent high savings ratios, although much will depend on just how much unemployment rises.
“Meanwhile, the relative resilience of the labour market so far should also provide some reassurance to the Bank of England. In the minutes of its December meeting, the MPC considered that the extension of the Government’s employment support schemes was likely to limit the near-term rise in unemployment significantly, although it did consider a substantial further increase was still likely over the next few quarters. Latest data show the unemployment rate only edged up to 5.0% in the three months to November.
“Ongoing fiscal support for the economy further eases pressure for more Bank of England action with January seeing the Chancellor announce a further £4.6bn worth of grants and financial support for companies in sectors such as hospitality, retail and leisure.
“The UK-EU Free Trade Agreement (FTA) also removes a downside risk to the economy that was considered at the last MPC meeting in December, even if the FTA is somewhat limited.
“The combination of these factors supports the EY ITEM Club’s belief that the MPC will decide that the economy does not need further stimulus for now at least. It should also be noted that the £150bn of extra asset purchases announced last November means that the spending programme will last through 2021 at the current rate.”
Negative interest rates remain unlikely
Howard Archer continues: “If the MPC does decide that more stimulus is warranted for the UK economy over the coming months, the EY ITEM Club would expect it to be in the form of more asset purchases.
“While the EY ITEM Club would not rule out negative interest rates, it remains doubtful the Bank of England would introduce them. The Bank of England has been conducting a review into negative interest rates and it is expected to release a report on the feasibility of cutting rates below zero on Thursday.
“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, observing that none of the conditions that would justify taking interest rates negative have been met. Potentially significantly, speaking earlier in January, the Bank of England Governor appeared to take a sceptical view of negative interest rates.”