December BoE MPC Preview: Preparing for the worst
By Jeremy Hawkins, Senior European Economist
December 15, 2020
With the BoE having already delivered a surprisingly stimulative package just last month, the December MPC meeting should have been an easy call. However, although at the time of writing, market expectations are still for no change, the now very real risk of a no-deal Brexit being announced over the next few days means that policy could yet be eased again. Late last month BoE Governor Andrew Bailey warned that the long-term economic cost of a no-deal Brexit would be bigger than the damage caused by Covid-19. The Bank clearly showed its willingness to act promptly and outside of its scheduled meetings during the first wave of coronavirus, so failure to reach a post-Brexit trade deal by year-end could easily prompt additional emergency action at almost any time.
November’s deliberations saw the overall QE ceiling raised by £150 billion to £895 billion and extended the programme’s duration until the end of 2021. As a result, there is certainly no immediate technical pressure for any further modifications and, Brexit issues aside, the firm consensus for Thursday’s announcement is no change in either net asset purchases or the record low 0.10 percent Bank Rate. The November vote was a unanimous 9-0 and it seems likely that this week’s meeting will produce a similar outcome.
However, speculation about a cut in Bank Rate (even with a Brexit deal) has not gone away altogether. External MPC member Silvana Tenreyro has made plain her view that negative interest rates have been beneficial to the recovery in the Eurozone and earlier this month her fellow rate-setter Michael Saunders suggested that the effective lower bound (ELB) is probably slightly below zero. Results of the Bank’s review into the likely effects of negative interest rates are expected soon. That said, Chief Economist Andy Haldane is on the record as saying that he was not even sure that he would have voted in favour of additional QE last month had the imminent arrival of a Covid-19 vaccine been known at that time. Consequently, even another unanimous decision on Thursday would probably only mask considerable uncertainty on the part of the MPC as a whole about what to do next.
Following their collapse between February and April, all of the major (non-agricultural) production sectors have seen a solid rebound. Even so, growth has slowed in recent months and, as of October, GDP was still nearly 8 percent short of its pre-pandemic level with industrial production down 4.4 percent and the key services sector off some 8.6 percent. That said, manufacturing seems to have avoided the worst effects of the latest Covid-19 containment measures and October industrial production was nearly 2 percent above its third quarter average. The November sector PMI (55.6) pointed to a solid performance in mid-quarter too. Consumer demand has recovered much more and October’s retail sales report put volumes some 6.7 percent above their lockdown mark in February. However, new Covid-19 restrictions will dampen spending in November and December.
In any event, the Bank’s remit is to hit a 2 percent CPI inflation target and its attainment remains as elusive as ever. The yearly rate stood at just 0.7 percent in October, up from 0.5 percent in September but still nowhere close to target and extending the run of sub-2 percent outturns to some 15 months. Underlying pressures, notably in the wages market, have picked up somewhat since November’s discussions but average pay rates are still short of their February levels and are being biased up by the return of some workers from furlough as well as by disproportionately heavy job losses amongst the lower paid.
The second nationwide lockdown which ran from 4 November to 2 December was not as harsh as in April/May but activity in services will still have suffered significantly. November GDP almost certainly contracted and the likelihood is that the fourth quarter will also register negative growth. Indeed, as of tomorrow restrictions in London will be raised from their current tier 2 level to tier 3. This will put an extra 10.8 million people under the strictest regulations and will mean that more than 60 percent of the population will again be in near-lockdown conditions. The move essentially guarantees another major hit to economic activity, notably in the hospitality industry which already accounts for about a third of the 819,000 overall job losses recorded since February.
Against this backdrop, a no-deal Brexit is just about the last thing that the UK corporate sector would put on its Christmas list. There may yet be a trade deal but even if one can be agreed, it will be only limited and come too late for many firms. Most surveys suggest that uncertainty over the outcome has been so high for so long that a large proportion of UK businesses is simply not geared up for the expiration of the current transition period at year-end. The BoE’s November survey of its Decision Maker Panel (DMP) found just 6 percent of those companies impacted were fully prepared for the start of the new regime and nearly a third either only partially or not prepared at all. As it is, precautionary stockpiling has provided a temporary boost to business activity in recent months that could be at the expense of an anticipated rebound in economic growth next quarter.
In addition to Covid-19 developments, it will be the response by businesses to what will inevitably be at least some barriers to EU-UK trade that shapes BoE policy over coming months. All of which makes for a highly uncertain and potentially very volatile near-term outlook for UK financial markets irrespective of how the MPC votes this week. Facing the twin risks of a post-Christmas escalation in Covid-19 infections and a no-deal Brexit, the BoE really needs to be prepared for the worst.