May BoE MPC Preview: Time to taper?
By Jeremy Hawkins, Senior European Economist
May 4, 2021
Forecasters see little chance of any major change in policy at Thursday’s BoE MPC announcement. However, early signs of a potentially sharp rebound in UK economic activity this quarter have significantly eased pressure for aggressive monetary accommodation and the release of what should be a markedly more upbeat May Monetary Policy Report (MPR) could pave the way for some limited tinkering with the QE programme.
The current £895 billion ceiling on overall QE, which comprises £875 billion of gilts and £20 billion of corporate bonds, was originally supposed to be reached at the end of the year. However, at the recent purchase pace of about £4.4 billion a week, the target will be overshot by the middle of September. An increase in the ceiling is not on the cards and would be hard to sell in the face of a stronger economic forecast so either the end-date must be brought forward or the buying rate tapered. The likelihood is that the MPC will opt for a smooth transition away from QE making a cut in asset purchases the more probable path. That said, so long as the ceiling remains intact any impact on financial markets should be limited – and largely psychological as investors contemplate the next major shift in policy. To this end, the likely effects of negative interest rates are still being studied and, in the increasingly unlikely event that Bank Rate (currently 0.10 percent) were to be cut below zero, the Bank in February signalled that it would not be for at least six months.
Under the weight of the third nationwide lockdown, the economy almost certainly contracted in the first quarter. However, weakness looks to have been largely concentrated at the start of the period when January real GDP fell 2.3 percent on the month. February saw a modest 0.4 percent rebound and very strong retail sales point to another month of positive growth in March. Moreover, following a partial lifting of lockdown restrictions in late March, consumer and business surveys have pointed to a very robust April. In particular, the PMI composite output index signalled the best period for private sector business activity since late-2013, crucially including a sizeable improvement in the key services sector. High frequency data also suggest a sharp pick-up in foot traffic in retail sector outlets and, bolstered by the extended stamp duty holiday, the housing market is booming.
Inflation is still well below target but the February MPR forecast a rise above 2 percent by the first quarter of 2022 and, for now at least, the MPC is anyway much more focussed on the labour market. Here recent news has been cautiously positive too.ILO unemployment in the three months to February posted its first quarterly decline since the fourth quarter of 2019 and while employment also fell, it decreased by the least since the coronavirus first arrived. Usual working hours have also increased and vacancies are at a 1-year high. That said, the government’s Coronavirus Job Retention Scheme (CJRS) continues to provide a sizeable safety net and it remains to be seen how the market will respond to the withdrawal of the programme, currently scheduled for September.
In any event, since the March MPC meeting the domestic economy has fairly consistently outperformed market expectations – in fact, Econoday’s economic consensus divergence index (ECDI) has hardly been out of positive surprise territory since the middle of February. The BoE’s February MPR forecast of a 4 percent quarterly fall in first quarter GDP looks likely to prove well wide of the mark.
There have even been some slightly better developments regarding post-Brexit trade with the EU. Brexit hit flows hard in January and continued to have a negative effect in February. However, the mid-quarter impact would appear to have diminished significantly. Hence, having slumped a remarkable 42 percent on the year at the start of 2021, goods exports to the EU were down a much smaller, albeit still very steep, 12 percent in February. Even so, some sectors continue to be badly affected, notably food and drink where a near-41 percent drop in sales to the EU contrasted markedly with an almost 9 percent rise to non-EU countries.
As at previous MPC meetings, crucial to the BoE’s economic projections will be the latest Covid developments and here the news has been uniformly positive. Despite some medical issues with the AstraZenica and Johnson & Johnson jabs, the vaccination rollout has continued apace and has had a major impact on controlling the virus. On current trends, the government’s roadmap, which sees the removal of all legal restrictions on social contact on 21 June, remains firmly on track. If so, high levels of pent-up demand combined with near-record household savings could well pave the way for a consumer boom in the second half of the year.
Against this backdrop, the MPC is likely to sound much less dovish than in a long while and could well opt to follow the Bank of Canada’s move late last month by reducing its QE asset purchase rate. Economic uncertainty levels remain high, notably surrounding the contrasting effects of greater consumer freedom versus the prospective end to the furlough scheme, but downside risks to the economy would seem to be fading. An early hike in interest rates is certainly not on the table but even just a subtle adjustment to QE this week would probably be enough to get financial markets thinking more about when the first full-blown tightening might finally be delivered.