August BoE MPC Preview: Bye, bye QE?
By Jeremy Hawkins, Senior European Economist
August 2, 2021
The August MPC announcement promises to be one of the more important in a while. In line with many other central banks, the UK monetary authority has watched domestic inflation rise while maintaining that the acceleration would be just temporary and attributable to a range of one-off factors. However, Governor Andrew Bailey has acknowledged that recent increases have been surprisingly sharp and both Deputy Governor Dave Ramsden and fellow MPC member Michael Saunders have suggested that now is the time to reconsider the need for such a highly accommodative monetary stance. Quantitative tightening (QT), let alone an outright hike in Bank Rate, will not be on the table at this time but a possible early end to QE asset purchases will most definitely be hotly debated. Much will depend upon the updated economic forecasts contained in the new Monetary Policy Report (MPR), also released on Thursday.
Since last November, the overall QE ceiling has stood at £895 billion within which gilts dominate with an upper limit of £875 billion. Following the May MPC meeting, weekly asset purchases have been running at around the £3.4 billion mark and going into this week’s discussion slightly more than £50 billion is still available to fund additional buying. Consequently, compared with earlier plans, any decision to halt the programme now would reduce the final stock of QE by that amount. That said, note that stopping purchases would not imply a monetary tightening – that would require the BoE to shrink its balance sheet by selling assets and neither would it have any immediate implications for Bank Rate. However, it could influence the eventual tightening process should, as is possible, the announcement be accompanied by a change to the Bank’s tightening guidance. Under former Governor Mark Carney, reducing the stock of QE (i.e. QT) was not expected to begin until Bank Rate had reached around 1.5 percent. However, Andrew Bailey seems to prefer a combined approach whereby QE is unwound alongside rising interest rates. This could mean reducing the interest rate threshold for QT to something much closer to Bank Rate’s current 0.10 percent level. Back in February the BoE indicated that it would be reviewing this guidance and there could be some update on Thursday.
The key question facing the policymakers is whether rising inflation is only transitory. Taken at face value, the data look ominous. The core CPI rate has climbed almost a full percentage point since December and now stands above target for the first time since August 2018. Regular earnings growth is easily at a record high and factory gate inflation has climbed nearly 5 percentage points in just the last eight months. However, Covid effects continue to cloud many economic reports, notably wages where compositional shifts in employment have provided a significant boost. Importantly too, all along the Bank has expressed its concern that the prospective withdrawal of fiscal stimulus could damage recovery prospects. In particular, the Coronavirus Job Retention Scheme is now being phased out and will be terminated altogether next month. At least some MPC members – notably doves Gertjan Vlieghe and Jonathan Haskel – will want to see how the economy adjusts to reduced government support before pulling the plug on QE.
Meantime, the real economy seems to be recovering well and GDP has expanded every month since its lockdown-inspired slump in January. The gradual removal of Covid restrictions has provided a much-needed boost to demand, notably recently to the hospitability industry, and all the main production sectors are now expanding at a healthy clip. Vacancies have been expanding rapidly too. Even so, the rebound is far from complete and total output in May was still more than 3 percent below its pre-pandemic level in February last year while payroll employment was down 206,000 and the ILO unemployment rate up 0.9 percentage points. In other words, there is something in the data for the MPC’s doves and hawks alike.
In favour of no change in policy, the economy has generally underperformed market expectations since the June meeting – Econoday’s economic consensus divergence index (ECDI) has been in negative surprise territory for most of the time since late June. That said, at minus 11, the current level suggests that overall activity is lagging only slightly and probably not by enough to give the doves the upper hand.
In fact, even if the supply-side of the economy is running a little cool, it is not helping to keep inflation in check. Rather, with household spending recovering significantly more quickly, the relative sluggishness of output is simply promoting excess demand. As of May, retail sales volumes had expanded some 9 percent versus their pre-crisis level while industrial production was still some 2.6 percent short. To this end, faster GDP growth would help to ease inflationary pressures but, if anything, supply bottlenecks look likely to get worse before they improve.
The economic outlook also remains clouded due to Covid. New cases caused by the Delta variant rose ominously steeply in June and early July but have declined quite sharply since. This may be attributable to the start of the school holidays or the success of the vaccine rollout or, in the best-case scenario, it means that the UK is now close to herd immunity. In any event, the scientific community remains cautious and with the economy now essentially fully open again, upcoming statistics will be watched especially closely for signs that restrictions were relaxed too soon.
Against this backdrop, Thursday’s policy outcome is a close call and on QE a narrower split decision than in June (8-1) seems very probable. The absence of former Chief Economist, hawk and lone June dissenter Andy Haldane who left the Bank after the last meeting must reduce the chances of any move. However, there are clearly now other members who also believe that rising inflation is in danger of becoming embedded and there might be just enough of them to bring the 12-year-old QE programme to a close. The market consensus favours no change but, either way, financial markets will be following Thursday’s announcement even more closely than normal.