Bank of England Preview: Dovish signals expected ahead of downside dangers

Since last month’s MPC meeting, GDP figures have bounced back after the sharpest drop on record in the second quarter. The economy was left some 22% smaller than its pre-pandemic peak, the worst toll on any G7 nation, but this quarter has started off in more promising shape, expanding by a record 8.7% in June. Domestic data has been reasonably upbeat with pent-up demand and considerable fiscal support, especially the furlough scheme, containing job losses.

Mood darkening

This rebound, with Haldane, the Chief Economist, notably extolling the ‘V-shaped’ recovery should mean the Bank will keep its powder dry for more testing times expected in the months ahead. However, downside risks were acknowledged recently by Governor Bailey in last week’s Treasury Select Committee testimony who sounded more balanced than he has been, while fellow MPC members, Vlieghe and Ramsden, were somewhat more gloomy. Saunders reaffirmed this by saying he considers it quite likely that more easing will be appropriate at some stage.

So, the vote will be of some interest to see if there is any kind of split and the minutes may show a less confident MPC.

Brexit and Covid headwinds ahead

The meeting takes place amid a backdrop of receding fiscal support with the Chancellor ruling out extending the furlough scheme beyond October, while reportedly laying the groundwork for tax rises in the Autumn. The unemployment rate has so far hovered around previous levels of 3.9%, but the Bank estimates that this will jump higher to 7.5% in the last quarter of the year. There is much concern about the cliff edge when the scheme ends and any comments by the MPC around fiscal policy, especially into next year will be keenly analysed.

Other issues that may threaten the recovery include the increasing risk of a no-deal Brexit. While most observers believe a deal will be reached in some form, the clock is ticking towards the mid-October deadline with both London and Brussels threatening to walk away from the negotiating table. It would appear there is too much at stake for this to happen, but official Brexit negotiations are now on hold until 28 September.

The increasing number of regional lockdowns will be another issue to contend with, as rising risks of a more permanent hit to GDP may become apparent. Tightening distancing rules and escalating infection rates will only add to this ahead of winter, which will continue to hurt consumer confidence and business investment.

What’s left in the toolbox?

The MPC may want to shore up a fragile recovery and the increased uncertainty at some point, with many expecting additional QE at its November meeting when it releases more economic forecasts. The current QE program has reduced its purchases to around £20bn per month from a peak of £60bn, which means the Bank will exhaust the additional £100bn by December.

As for cutting rates to zero or even beyond, the Bank recently argued that negative rates might be ‘less effective as a tool to stimulate the economy’. However, money markets are now pricing in a move to zero by February, hastened by the recent Brexit brouhaha, with a growing chance of a cut into negative territory later in 2021.

Market Impact

With all policy levers to remain on hold and dovish hints expected, sterling may take it cues from the market’s general risk appetite. Parliament will begin to debate the Internal Market Bill this week but the sharp selloff in the pound has left cable nearing oversold levels. The risk backdrop is still fragile though, so watch 1.2775 as a long-term pivot going back to the aftermath of the Brexit referendum, ahead of support at the long-term moving averages.