Bank of England Preview: Beyond the bounce and ready to do more

No changes are expected from the MPC with policy to be kept on hold at 0.10% and a unanimous vote in favour of no QE change. The asset purchase target will remain at £745bn following the £100bn of extra quantitative easing announced at its last meeting in June. This was seen as sufficient to last to the end of the year but disappointed some who believed more QE was necessary to navigate through the potential Brexit bumps that might appear towards the end of the year. In addition, a lower speed of monetisation was revealed due to an easing in liquidity problems in money markets.

More positive economic assessments

May’s meeting saw a slight departure from the bank’s usual MPR in that the MPC produced a ‘plausible’ scenario for the path of the economy over the next three years (in line with other major central banks), rather than the usual forecasts, Since then, near-term data has pointed to those projections being too pessimistic with growth surprising to the upside in the first half of the year. There may also be changes to the shape of the recovery and the timings of a return to ‘normal’ pre-Covid levels of activity.

The MPC may note that the economy has enjoyed further recovery momentum recently. For example, retail sales printed above last year’s June levels and July’s ‘flash’ PMI hit five-year highs. The immediate rise in the unemployment rate has also been less severe than the bank forecast, remaining at 3.9% against the MPC’s expectations of a jump to 4.6%.

With an improved growth outlook may come more positive inflation, especially due to higher oil effects. Of course, sterling has strengthened since the last forecasts, but it is only marginally higher on a trade-weighted basis so should only be a limited drag. A temporary, albeit more significant deflationary impulse will be Chancellor Sunak’s recent measures including the sales tax cut for several sectors, as well as the August Eat Out scheme.

Hawks v Doves

The notable dissenter voting against an extension of further QE at the June meeting was chief economist Haldane, as he saw the recovery ‘materially faster’ than experienced in May and believed output losses would be half those feared the previous month. Governor Bailey also added slightly to this more hawkish tilt when commenting on the size and expansion of the bank’s balance sheet and the need to keep it contained. That said, the new Governor also acknowledged downside risks to the outlook stemming from a cautious private sector.

These ‘internal’ views come in stark contrast to more dovish MPC members like Tenreyro and Haskel who highlight the output gap and with it weak inflationary pressures. They see downside risks stemming from a much weaker labour market once the government furlough scheme ends in the autumn. Indeed, there were only around 6 million jobs covered by that scheme at the time of the May forecasts, whereas it is now supporting over 12 million.

Future policy measures

Allied to this more cautious view is the obvious fact that coronavirus infection rates are increasing in parts of the UK and across Europe. Uncertainty is still high on how quickly the economy can return to anything like pre-Covid levels with social distancing measures and the threat of swift regional lockdowns likely to hamper confidence, consumer activity and investment.

Under new Governor Bailey’s stewardship, the bank is acting gradually as seen with dovish guidance and no new measures in May, then delivered on in June. So it is with the internal review at the bank on negative rates, which isn’t meant to be finalised until the latter part of the second half of this year. Governor Bailey himself stated in the last press conference that negative rates were not in any sense imminent and it seems there will be some disappointment if there are no firm signs, with hints emerging about its feasibility being the minimum required for many bank watchers. Interestingly, the curve is currently pricing in around an 80% chance of a 25bp cut in the Bank rate to -0.15% by early 2022.

Other more immediate tools available include another rate cut to zero and additional QE with a more flexible approach to purchases. We have also mentioned other more targeted policies in the past, like lowering the rate on the Term Funding Scheme which would help banks provision of credit.

Ready to act, if needed

Overall, expectations are for guarded optimism tempered by the risks which lie ahead. How quickly the economy recovers in the medium term is the key question and the numerous options still left in the MPC’s toolbox need to be on display to satisfy markets who are increasingly concerned by the outlook , which has the Brexit uncertainty hovering over it. Little mention of future policy action would be a shock and open the door for GBP to extend recent advances.