- The odds strongly favour the Bank of England continuing to sit tight on monetary policy on Thursday, following the May Monetary Policy Committee (MPC) meeting, says the EY ITEM Club
- The EY ITEM Club expects unanimous 9-0 decisions by the MPC to keep interest rates at 0.10% and the stock of asset purchases at £895bn
- It is unlikely that the Bank of England will need to provide further monetary stimulus to support the UK economy, barring a renewed future downturn
- While lockdown restrictions meant that the economy almost certainly contracted again in Q1, the decline in GDP looks to have been considerably less than originally expected. There are early indications that the economy has had a strong start to Q2, benefitting from restrictions being eased on 12 April. Meanwhile, the labour market is showing impressive resilience. There was also increased near-term support for the economy provided in the March Budget
- The EY ITEM Club expects the Bank of England to acknowledge the improved UK economic performance by markedly lifting its near-term GDP growth projections in its new forecasts. The EY ITEM Club also expects the Bank to lower its unemployment projections
- While the Bank is likely to acknowledge rising inflationary risks, the EY ITEM Club expects it to want to see evidence inflation will be sustained at the target rate of 2% before tightening policy
- The EY ITEM Club believes that the Bank of England's eventual next move will be to tighten policy, initially through edging interest rates up from the current level of 0.10%. The EY ITEM Club suspects that the case for further Bank of England support for the economy will continue to wane as recovery increasingly takes hold
- The EY ITEM Club believes that the Bank of England is most likely to hold off from acting throughout 2021, keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn
- There is a growing possibility that the Bank of England could tighten monetary policy in 2022, although early-2023 is more likely at the moment
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“The odds strongly favour the Bank of England’s Monetary Policy Committee (MPC) once again sitting tight at their May meeting. It is likely that there will continue to be unanimous 9-0 votes within the MPC both for keeping interest rates unchanged at 0.10% and for maintaining the targeted stock of asset purchases at £895bn.
“At the last MPC meeting in mid-March, all members voted for unchanged monetary policy as they had done in both of their previous meetings in February and December. At the March meeting, the MPC came across overall as more upbeat on the UK economy.
“While the minutes did not come across as significantly more concerned overall about inflation, there was acknowledgement that there was a range of views across MPC members on the degree of spare capacity in the economy currently, whether demand would outstrip supply during the recovery from the pandemic, and how the assessment of supply should take into account the unique nature of the economic shock from the pandemic. The minutes recorded that the MPC considered that consumer price inflation would rise to around its 2% target level in the spring, lifted primarily by unfavourable oil base effects and increasing energy prices. Inflation was projected to be close to 2% over the medium term.
“Concluding, the MPC indicated that it is still prepared to take further stimulus action to support the economy should it fail to pick up as anticipated or if downside risks intensify. The MPC indicated overall it will not be minded to tighten monetary policy any time soon and that the committee would wait at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.
“Developments since the March MPC meeting have largely continued to be positive for both the UK economy and the labour market. GDP seemingly contracted appreciably less-than-expected in the first quarter and the economy looks to have started the second quarter very much on the front foot, benefitting from a significant easing of restrictions on 12 April and the continued vaccine roll-out. The further near-term support to the economy provided in March’s Budget also seems to have lifted business and consumer confidence.
“Significantly, the labour market is currently showing considerable resilience and survey evidence points to more confident businesses being increasingly prepared to take on workers. While it still looks likely that some jobs will be lost when the furlough scheme ends in September, it also looks like the peak in the unemployment rate will be less than the Bank of England previously forecast.
“Consequently, it looks highly likely that the Bank of England will significantly revise up its GDP growth forecast for the UK economy in 2021 – although it may partly offset this by lowering expected growth in 2022 – and improve its unemployment projections.
“In its last set of forecasts contained in the February Quarterly Monetary Policy Report, the Bank of England saw GDP growing 5.0% in 2021 and 7.25% in 2022 after an estimated contraction of 10.0% in 2020 – the actual outturn was a slightly less-than-expected decline of 9.8%. Regarding the labour market, the Bank of England observed that the unemployment rate had risen less than expected although the Bank considered that the degree of slack in the labour market was likely higher than shown. The Bank of England saw the unemployment rate averaging 6.5% in 2021. However, latest data show the unemployment rate dipped to 4.9% in the three months to February and the Chancellor also extended the jobs furlough scheme to the end of September in the March Budget.
“The Bank of England may modestly step up its caution over potential future inflationary pressures on its May forecasts, but the EY ITEM Club does not expect the Bank to markedly change its inflation forecasts outlook.”