BoE Preview: No Change Expected

By Peder Beck-Friis, Portfolio Manager, Global Macro | BoE will announce its next policy decision on Thursday (noon). We expect no change in policy parameters.

Current policy: Bank rate at +0.1%. OngoingQE, total YTD envelope of +£300bn (+£232bn of which bought so far), with latest +100bn announced in June.At the last meeting in June, BoE also added a weak form of forward guidance (“The Committee does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.”)

Expectation: No policy change on Thursday. With QE purchases ongoing and the recovery under way, we see little reason to stimulate further at this juncture, and instead expect BoE to wait and see how the virus/recovery takes shape before deciding on next steps. Looking ahead, we expect the BoE to top up its QE programme by year-end and possibly strengthen its forward guidance. Negative rates are unlikely, especially in the short run.

More QE ahead. BoEhas so far been the most aggressive central bank in terms of government bond purchases. In July, it slowed the weekly purchase pace from +£6.9bn to +£4.4bn, which should exhaust the current envelope by mid-December. Some MPC members (e.g. Ramsden, Saunders) have stressed that there is significant room to add more QE. Against that, others (e.g. Bailey, Vlieghe) have highlighted that the effects of QE are likely state contingent, more effective in times of market distress/illiquidity, with the stock of available assets to purchase as the key constraint for effective QE. Although not an imminent issue in current conditions, this speaks to the BoE possibly using its balance sheet as a more counter-cyclical policy tool going forward — unwinding the balance sheet in good times (small effect) to create more headroom for QE to work in bad times (large effect). With the recovery losing pace in autumn and inflation well below target, we expect the BoE to add slightly (+£50-100bn) to its QE envelope in November or December. But given recent comments, we are skeptical of a larger QE package, absent a liquidity/market crisis.

Negative rates still unlikely. The message from BoE on negative rates has been slightly confusing: (1) the lower bound review is still ongoing; (2) negative rates are part of the toolbox; but (3) BoE does not plan to use them at the moment. The BoE has importantly highlighted two factors determining the effectiveness of negative rates: (1) the structure of the financial system, with a high reliance on deposit funding, like in the UK, weakening the transmission of negative rates; and (2) the state of the business cycle, with negative rates less effective in a downturn, as they impair bank balance sheets at a time when loan losses are high. The second point suggests the bar for negative rates is especially high in the short run. Negative rates would instead more likely be considered — though still unlikely to be implemented in our view — in an environment in which activity has normalised and bank balance sheets are not under immediate pressure.

BoE unlikely to change its remit. Average inflation targeting seems unlikely in the UK, as: (1) unlike the US and Eurozone, UK has no “inflation problem”, with core inflation having averaged +2.0% since 2010 and with inflation expectations still fairly high; and (2) existing framework is already flexible, allowing for some inflation over/undershoots given strong FX pass-through (e.g. after 2016 FX depreciation). Importantly, too, in the UK, it’s the Treasury and Chancellor that set the inflation target, not BoE.   

Recovery underway, but momentum likely to fall ahead. Recentmacro datahaveon balance been good, broadly in line with BoE’s recent forecast. The recovery is clearly under way, with monthly GDP in July having recovered around half of the output lost at the peak of the crisis. More timely indicators (PMI, mobility, other surveys) point to another decent gain in August. But there are considerable risks ahead. The furlough scheme is set to end in October. There are some tentative signs of fiscal fatigue. And renewed Brexit tensions add another layer of uncertainty. We expect the recovery pace to slow ahead (from September onwards), with GDP contracting 10.4% in 2020, slightly more pessimistic than BoE’s forecast at -9.5%. We do not expect the GDP level to return to its pre-crisis peak until 2022.