- As largely expected, the Bank of England held off from providing more stimulus for the UK economy at the February Monetary Policy Committee (MPC) meeting
- The Bank observed that the UK economy had performed much better than had been expected in Q4 2020 when it likely grew around 0.5% quarter-on-quarter (q/q). The MPC acknowledged that Q1 2021 was much more challenging due to the lockdown and sees GDP contracting around 4% q/q
- The MPC chose to look ahead to the UK economy’s brighter longer-term prospects. The progressive roll-out of the COVID-19 vaccines was seen facilitating the easing of restrictions and opening up of the economy from Q2 2021, paving the way for firming growth. The Bank of England sees GDP growth of 5.0% in 2021 and 7.25% in 2022
- The MPC did make it clear that they remain fully prepared to take further stimulus action to support the economy should it fail to improve as anticipated or if downside risks intensify
- In its review of negative interest rates, the Bank of England reported that it would take banks at least six months to prepare for such a move. However, it made clear that this did not necessarily mean that negative interest rates would be introduced
- The EY ITEM Club suspects that the case for further Bank of England support for the economy will wane from Q2 as recovery takes hold and develops as the COVID-19 vaccine is rolled out
- 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 contrast to the Bank’s active 2020
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“The Bank of England held off from providing more help for the UK economy at the February meeting of the Monetary Policy Committee (MPC) despite the weaker lockdown-affected outlook for the first quarter.
“The MPC's decision not to provide more stimulus was largely expected – although there had been some thought that the Bank of England could announce some more asset purchases. In the end, there were unanimous 9-0 votes within the MPC for both keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn.
“The Bank of England observed that the economy had been “materially stronger” in the fourth quarter of 2020 than had been expected back at its November meeting and likely expanded by around 0.5% quarter-on-quarter. Consequently, the Bank believed that GDP was around 8% lower in Q4 2020 than in Q4 2019.
“The MPC acknowledged that the situation facing the UK economy in the first quarter of 2021 was more challenging than they had previously anticipated due to COVID-19 restrictions and it was likely to perform worse than in Q4 2020, but nevertheless expects the negative impact to be far less than in Q2 2020. The Bank sees GDP contracting around 4% quarter-on-quarter in the first quarter of 2021.
“The Committee chose to look to the brighter longer-term prospects for the economy which will stem from the progressive roll-out of the COVID-19 vaccines. The MPC commented “GDP is projected to recover rapidly towards pre-COVID levels over 2021, as the vaccination programme is assumed to lead to an easing of COVID -related restrictions and people’s health concerns. Projected activity is also supported by the substantial fiscal and monetary policy actions already announced. Further out, the pace of GDP growth slows as the boost from these factors fades. Spare capacity in the economy is eliminated as activity picks up during 2021.””
Howard Archer continues: “This view was reflected in the Bank of England’s new forecast for the UK economy, which sees GDP growing 5.0% in 2021 and 7.25% in 2022 after estimated contraction of 10.0% in 2020. The Bank has substantially scaled back expected growth in 2021 from the 7.25% expected back in November but it is more optimistic about 2022 when growth was previously seen at 6.25%. The estimated contraction in 2020 has also been cut to 10.0% from 11.0%.
“The Bank of England also observed that the unemployment rate had risen less than expected – to 5.0% rather than 5.8% – although they considered that the degree of slack in the labour market was likely higher than this. The Bank of England has modestly scaled back the expected rise in the unemployment rate which is now seen averaging 6.5% in 2021 rather than 6.75%.
“Consumer price inflation (0.6% in December) is seen staying around its current level in the near term before rising to over 1.5% in the spring due to oil and energy base effects, as well as the temporary VAT cut for the hospitality and leisure sector ending at the end of March. It is seen rising to average 2% in the fourth quarter of 2021 and then modestly above target at 2.25% in the fourth quarter of 2022, before easing back to average 2.0% in the fourth quarter of 2023.
“The MPC considers that the outlook for the UK economy remains particularly uncertain. Consequently, the MPC made it clear that they are prepared to take further stimulus action to support the economy should it fail to pick up as anticipated or if downside risks intensify.”
Negative interest rates remain unlikely
Howard Archer continues: “The Bank of England did report on the practicalities of introducing negative interest rates in the UK, coming to the conclusion that banks would need at least six months to prepare for such a move. The Bank noted the introduction of negative rates before these preparations have happened would be likely to create operational risks.
“The Bank made it clear that while it would be possible to introduce negative interest rates in the UK, this did not necessarily mean they would be enacted. The Bank said it did not want send a signal that it intended to set a negative Bank Rate at some point but that it “would be appropriate to start the preparations to provide the capability to do so if necessary in the future.””
Howard Archer adds: “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, while 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, the Bank of England Governor appeared to adopt a sceptical approach to negative interest rates in an online Bank of England event on 21 January, observing that international evidence to-date suggested negative interest rates were only effective in specific circumstances.”