- The odds always strongly favoured the Bank of England keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn following the May Monetary Policy Committee (MPC) meeting
- However, one MPC member voted to reduce the targeted stock of asset purchases by £50bn. The Bank also opted to taper the pace of asset purchases, reflecting the economy’s improved performance
- Acknowledging the improved near-term outlook for the UK economy, the Bank of England lifted its GDP forecast for 2021 to 7.25%. While lockdown restrictions meant the economy almost certainly contracted in Q1 2021, the decline in GDP looks to have been considerably less than originally expected. There are early indications of a strong start to Q2, with the benefit of a significant easing of restrictions on 12 April
- The Bank of England also lowered the expected peak in the unemployment rate. The labour market is showing significant resilience with companies' employment plans currently improving. On inflation, the Bank of England does not seem unduly concerned, although it does acknowledge the uncertainties facing both the supply and demand sides of the economy
- The increased near-term support for the economy provided in the March Budget has diluted the case for further Bank of England economic support
- Overall, while the Bank of England is clearly much more optimistic about the UK economy in the near term, the MPC has significant uncertainties over the longer-term outlook and is seemingly in no hurry to tighten monetary policy
- There is a growing possibility that the Bank of England could tighten monetary policy in 2022, although the EY ITEM Club considers early-2023 to be more likely at the moment. The EY ITEM Club expects that the Bank of England will almost certainly hold off from acting throughout 2021, keeping interest rates at 0.10% and the targeted stock of asset purchases at £895bn.
Howard Archer, chief economic advisor to the EY ITEM Club, says:
“There was never any real doubt that the Bank of England’s Monetary Policy Committee (MPC) would either leave interest rates unchanged at 0.10% or maintain the targeted stock of asset purchases at £895bn. However, while there a unanimous 9-0 MPC vote for the interest rate decision, one MPC member – Andy Haldane – voted to reduce the asset purchase target by £50bn, reflecting his upbeat view of the economy and concerns over the upside risks to inflation.
“The MPC did decide to slow the pace of asset purchases, which are expected to last through to the end of the year. Specifically, the minutes reported that ‘the pace of these continuing purchases could now be slowed somewhat.’ Asset purchases are seen amounting to £3.4bn a week between May and August compared to the previous rate of £4.4bn.
“At its May meeting, the MPC appeared much more upbeat overall on the UK economy – certainly in the near-term. The Committee considered that UK GDP likely contracted by around 1.5% quarter-on-quarter in Q1 2021, much less than had been anticipated in its February forecast. Furthermore, GDP is expected to rise ‘sharply’ in Q2 and then increase over the rest of the year in the absence of any new COVID-19 restrictions.
“This was reflected in the Bank of England's new forecasts, which most notably increased projected GDP growth for 2021 to 7.25% from the 5.0% rate that had been expected in February. Despite the near-term optimism, the Bank of England still has uncertainties about the longer-term outlook, such as the possibility of a new COVID-19 outbreak. The bank partly offset its stronger GDP forecast for 2021 by cutting the growth forecast for 2022 to 5.75% from 7.25%. The 2023 GDP growth forecast is unchanged at 1.25%.
“The Bank of England was also significantly more optimistic about the labour market, reflecting its recent resilience, the stronger near-term economic outlook, and the extension of the furlough scheme to the end of September. The unemployment rate is now seen averaging 5.0% in 2021, instead of 6.5%. The expected average in 2022 has been reduced to 4.5% from 5.0%.
“On inflation, the Bank of England does not seem unduly concerned, although it does acknowledge the uncertainties facing both the supply and demand sides of the economy. Specifically, the May minutes state that ‘The weakness of recent CPI outturns has largely reflected the direct and indirect effects of Covid on the economy. As has been the case in recent MPC forecasts, inflation is projected to rise to close to the target in the near term as some of those effects fade. In the central projection, CPI inflation rises temporarily above the 2% target towards the end of 2021, owing mainly to developments in energy prices. These transitory developments should have few direct implications for inflation over the medium term, however. In the central projection, conditioned on the market path for interest rates, inflation returns to around 2% in the medium term.’
“Overall, while the Bank England is clearly more positive about the UK economy in the near-term, the MPC also has significant uncertainties about the longer-term outlook and are seemingly in no hurry to tighten monetary policy. The May minutes conclude that ‘The MPC will continue to monitor the situation closely and will take whatever 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.’”