Authored by George Buckley of Nomura
Today’s Bank of England decision to leave interest rates and the asset purchase target unchanged is not a surprise. After all, official rates are already at what the BoE considers to be their effective lower bound, and at its current pace the Bank has time to announce an expansion of its quantitative easing scheme at its 18 June meeting – two weeks before the £200bn envelope is due to run out. The fact that two (external) MPC members voted to increase asset purchases by a further £100bn at this month’s meeting supports the view that this will be delivered in June with a view to possibly tapering the speed of purchases as we move into the second half of the year.
The Bank’s forecasts for output showed an acute fall in GDP in the first half of this year (-30%). While the MPC argues that the recovery will be marred by more precautionary behaviour from firms and households it still sees a relatively swift move back to 2019 GDP levels, which would be a quicker return to peak than most previous UK recessions – and notably that associated with the global financial crisis. The Bank is thus right, in our view, to say that the risks to this set of forecasts look to be to the downside.
Another £100bn QE looks likely in June
The Bank of England announced this morning its decision to keep rates and its QE programme unchanged at 0.10% and £645bn respectively, as expected. However, the news seems dovish because the decision not to increase QE was not unanimous – two members (externals Jonathan Haskel and Michael Saunders) preferred to increase the amount of QE by a further £100bn, justifying this as needed to limit the extent of any economic “scarring” (i.e. a permanent hit to both the economy’s demand and supply sides). We adjusted our view recently calling for another £100bn of QE to be announced at the June meeting – after all, at its current pace the Bank will have used up all of its £200bn by early July and we doubt, given the depth of this crisis, that the Bank will want to exit from QE at that point. As such, a fresh mandate for more QE – at the very least to taper purchases during the rest of the year – will be needed before the current programme expires. The combination of today’s QE dissents and remarks by the Bank such as “the MPC…stands ready to take further action as necessary to support the economy” makes another £100bn of QE on 18 June highly likely in our view.
So far the Bank has already administered a substantial amount of policy support including: lowering Bank Rate in two steps from 0.75% to 0.10%, introducing a term funding scheme with the focus on SMEs to enable banks to borrow at rates close to Bank Rate, cutting the counter-cyclical capital buffer from 1% to zero, extending USD swap lines, administering the Covid Corporate Financing Facility (an HMT scheme) and restarting QE – purchasing £200bn of primarily gilts at a current rate of £13.5bn per week, but also including a total of £10bn extra corporate bonds. Another £100bn of QE announced next month would take total asset purchases since March to around 13.5% of 2019 GDP, and would go beyond simply scooping up the additional issuance that the DMO will likely announce over and above what was expected before the virus hit.
The Bank’s new forecasts
In today’s Monetary Policy Report the Bank published what it called a “plausible illustrative economic scenario”, where GDP is seen falling by 14% in 2020 (followed by a 15% rebound in 2021) and the unemployment rate broadly doubling to 8%. The drop in GDP in the first two quarters of the year is assumed by the Bank to be around 30% (with a 25% fall in Q2 alone), not that dissimilar to the Office for Budget Responsibility’s scenario. This is based on data showing, in the Bank’s own words, consumer spending to be down 30%, housing market activity “practically ceased”, companies’ sales down 45% (according to he Bank’ Decision Maker Panel survey) and business investment having halved.
As we’ve discussed on many occasions in the past, what’s probably more important than the absolute scale of the decline in activity in the first half of the year is the outlook thereafter. While the Bank describes its forecasts as being for activity to pick up “relatively rapidly”, the Bank also points to the fact that it expects it to take some time for activity to return to its previous path with precautionary behaviour by households and firms being somewhat persistent. This is a view with which we fully agree.
Remember too that while the BoE does see a larger percentage rebound in GDP in 2021 (15%) than the fall in 2020 (14%), the rise in GDP is coming from a lower base, so GDP remains below where it was in 2019 by around 1% in 2021 in the Bank’s scenario. That said, the (hopefully) temporary nature of the crisis is illustrated by the fact that relative to the global financial crisis this forecast shows a quicker rebound in output – in the GFC output peaked in 2007 and it took until 2012 (five years) before it surpassed that peak again. In the scenario the Bank laid out today, GDP returns back to peak in just three years (2022) – see Figure 1. However, we should reiterate here that the Bank does think the risks to its GDP profile are to the downside – particularly should we see “an even longer period of precautionary behaviour than assumed” and voluntary social distancing being “more material”.
As for the Bank’s inflation forecasts, it sees CPI inflation falling below 1% (i.e. below the boundary at which the Bank is required to write an open letter to the Chancellor explaining the miss) “in the next few months” – indeed we think it could be as soon as the April print published in a couple of weeks’ time that inflation falls below 1%, with our preliminary forecast for that print at 0.9% (down from the current 1.5%). That would be largely driven by lower petrol and utility (household energy and water bills) prices. However, in the Bank’s forecasts inflation remains well below its target not just this year but next year too – remaining around the 0.5% mark for both years. We see upside risk particularly to the 2021 forecast, depending of course on the pace of economic recovery.
Looking further ahead, the Bank says that it expects inflation to rise back to the 2% target in 2022; however, we would caution that the BoE’s models (and those of most other central banks to be fair) assume monetary policy credibility such that it would be a surprise were inflation much away from its target in the medium to longer term. It’s worth remembering that since 2004, when the Bank began publishing three-year-ahead forecasts for CPI inflation, the Bank has never published an end-horizon forecast for inflation more than 1pp deviant from its target. This is a point made by previous BoE Governor Mervyn King recently in an interview with the Society of Professional Economists.