February BoE MPC Preview: Positive or negative?
By Jeremy Hawkins, Senior European Economist
February 2, 2021
Financial markets are not too sure what to expect from Thursday’s BoE MPC announcement, especially since it coincides with the release of a new Monetary Policy Report (MPR). Since the December meeting, news has been mixed on both the economy and the coronavirus and policy comments from the MPC members themselves have hardly provided a uniform view. The November discussions saw a sizeable £150 billion added to the then £745 billion QE programme and even the end-of-year talks produced an extension to the Term Funding Scheme aimed at helping small and medium-sized enterprises (TFSME). Consequently, with the threat of no post-Brexit trade deal now safely avoided, the MPC could well opt to wait and see how its latest measures are working. Nonetheless, the economy is clearly in danger of falling into a second double-dip recession so there remains significant pressure for additional stimulus. To this end, the key question for this week concerns interest rates: specifically, has the Bank reversed its previous view that a negative Bank Rate would do the economy more harm than good and, if so, when should the drop into uncharted waters be delivered?
In recent weeks the Bank has been looking into the operational viability of negative interest rates and the results from last October’s consultations with financial institutions will be one key factor determining whether a sub-zero Bank Rate is even worth considering. So far, it seems that there is still no clear-cut agreement on the MPC. Probably the main proponent of a negative interest rate policy (NIRP) is external member Silvana Tenreyro who earlier this month reiterated her strongly held view that NIRP would boost growth and inflation. Her colleague Michael Saunders has also recently intimated that he would not be against such a move. However, other members are worried about the potential hit to bank profitability and the risk that subsequent efforts by lenders to boost earnings could prompt more risky lending practices, notably in the key housing market. BoE Governor Baily has pointed to considerable uncertainty over its impact, warning that when interest rates are negative, the ability of monetary policy to influence the economy is much less clear and that the whole calculus of how the banking system works changes. Some have suggested that NIRP would work better during the recovery phase. The bottom line would seem to be that a majority of MPC members are not yet convinced that a sub-zero Bank Rate is a good idea.
With regard to QE, net asset purchases are currently running at around £4.4 billion a week and at this pace the outstanding stock would not reach the overall £895 billion ceiling until late August. As such, there is no pressing technical need to modify the limit any time soon.
Nonetheless, the economy is struggling under the weight of Covid-19 restrictions and real GDP in November posted its first monthly contraction since its near-19 percent collapse in April just after the first virus wave struck. Retail sales slumped more than 4 percent in the same month and, despite a temporary and partial easing of restrictions, made back very little ground in December. Since then, consumer confidence has started falling again while business activity has plummeted on the back of the worst slump in services since last May. Meantime although inflation has climbed off November’s low, at just 0.6 percent in December, it remains nowhere near its 2-percent medium-term target.
In fact, despite its remit, inflation is currently not a big concern for the MPC. Rather, the focus seems to be much more on the real economy in general and the labour market in particular. The Bank is clearly concerned about how unemployment will respond to the planned termination of the present furlough programme at the end of April (although another extension cannot be ruled out). Interestingly, last month the BoE’s Chief Economist, Andy Haldane, postulated that if GDP was within 5 percentage points of its pre-crisis level when the scheme ends, there should be no further job losses at that point. His comments provide a new metric for markets to assess the near-term outlook for monetary policy. As of November, the economy was 3.7 percent short of Haldane’s threshold so it would seem that GDP will need to expand by at least this amount by April if the chances of more easing are not to increase significantly.
Meantime, the third nationwide lockdown introduced at the start of the year has succeeded in reversing the ominously sharp rise in virus infections that began in December. However, the latest peak in early January was much higher than seen previously and even now new cases are still slightly above November’s second wave high. As a result, any significant early easing of restrictions looks very unlikely and the planned reopening of schools, a government priority, has been pencilled in for no sooner than 8 March. In other words, containment measures will be a drag on economic growth for some while yet.
However, since the only sustainable way out of the pandemic is through vaccination, investors are now looking increasingly at how the vaccine rollout is shaping up. To this end, the UK is well ahead of the Eurozone, where deliveries have been particularly slow, and globally lies third behind just Israel and the UAE. In the face of generally disappointingly weak domestic economic data, the relatively fast rate of delivery has been a key factor underpinning the pound since the turn of the year – notably against the euro where it has appreciated around 2 percent. The vaccine focus could well remain a major source of support for the currency over coming weeks.
Fortunately, the signs are that the latest virus wave is not causing anything like the amount of damage to the UK (or global) economy that the first wave inflicted. Even so, GDP is already contracting again and the likelihood of reduced fiscal support as the government seeks to address its burgeoning borrowing requirement makes for additional downside risk over the medium-term. As a result, while no change in policy seems the most probable outcome on Thursday, a pre-emptive nod in favour of a lower Bank Rate at some point cannot be ruled out. The MPC might yet find enough positives in negative rates.