UK Reaction: BoE happy to wait-and-see as growth outlook improves

David Page, Head of Macro Research at AXA Investment Managers, comments on the latest development at the Bank of England:     

• The BoE left policy unchanged by unanimous vote as was widely expected.
• The minutes recorded a number of improvements to the short-run growth outlook, but was “less clear” that the medium-term outlook had improved.
• The BoE also noted “unusual uncertainty” over the outlook for the demand and supply balance and hence for the outlook for inflation.
• The minutes acknowledged rising yields and sterling, but states that overall financial conditions were broadly unchanged.  
• Overall and amidst elevated uncertainty, the BoE was clearly in wait-and-see mode – a prudent stance in the current environment.
• Yet the QE envelope is running down and currently applies a tapering ahead of other central banks which could exacerbate a tightening in financial conditions.
• For now the prospect of additional QE appears to have faded amidst the positive growth developments, but a tightening in financial conditions may yet necessitate a fine tune add to the QE envelope over the coming meetings.

The Bank of England (BoE) left policy unchanged in today’s announcement by unanimous vote as we and most in markets had expected. Bank Rate remained at 0.1%, the BoE retained a QE gilt target of £875bn (with current holdings of £765bn as of 17 March) and the QE corporate bond target was unchanged at £20bn (with CBPS holdings currently at that level).

The minutes recorded a string of developments that had improved the BoE’s near-term growth outlook. Eurozone and Emerging Market growth had performed better than expected, with signs of adaption to restrictions; the US stimulus was around twice the size the BoE had assumed in February and the minutes noted an expectation of positive spillovers for the UK economy. Domestically, the minutes noted that January’s 2.9% contraction had been “less weak” than expected; the Budget had included a significant easing in the fiscal stance as the Chancellor provided more short-term support to the economy and the planned lifting of restrictions across the UK was somewhat faster than the BoE had anticipated. In all the BoE suggested that this lifted the short-term outlook for UK growth, although it did add that the implications for the impact on the medium-term outlook were “less clear”.

However, the minutes also stressed that the outlook was unusually uncertain. This was the case in general where the positive developments could result in a quicker release of excess savings than the Bank had assumed, but where households and businesses may remain cautious in their spending, where vaccine disruption could alter the planned pace of easing restrictions and where new variant risk could pose an even bigger question. The outlook for the balance of supply and demand in the economy was even more uncertain, with particular relevance for the outlook to inflation.

This is clearly a situation where the Bank would happily leave policy in a wait-and-see mode. However, the BoE is gradually using up its announced QE envelope. The BoE stated that it had £110bn of asset purchases left of its £150bn announced in November, something that BoE member Dave Ramsden recently estimated would last until November at the current pace of purchases. This suggests, and the BoE has been explicit on this, that the pace of purchases would have to slow over the coming months if the BoE’s current envelope is to last across 2021 as the BoE intends. Such a tapering of asset purchases would come even as the Fed reiterated that it would not taper its own purchases until “substantial further progress” had been made towards its goals and as the ECB announced that it would “significantly” increase its weekly asset purchases to counter tightening financial conditions. Indeed, there is now some fundamental distance between ECB and BoE approach to QE. The ECB stated that the change in the pace of QE was a monetary policy decision. The BoE is more orthodox in seeing the pace of purchases as more of an operational decision, with the total envelope of QE as the monetary decision. Indeed, the BoE separately stated that it would not tighten policy until there was “clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably”. However, the Bank’s relatively sooner tapering of asset purchases is certainly something that could exacerbate increases in domestic yields and sterling.   

The minutes made note of tighter financial conditions today, noting that the rise in bond yields – driven by rising real rates – and the appreciation of sterling. However, in aggregate and the minutes noted against a backdrop of an easing in mortgage credit conditions, financial conditions across the UK were broadly unchanged since February. This suggests that the Bank is currently relaxed about asset price movements. This leaves the outlook for May’s next meeting uncertain. Against the backdrop of an improvement in the short-term growth outlook, we expect the MPC to be happy to leave its QE envelope unchanged. However, if markets place additional pressure on UK financial conditions, particularly sterling in the face of relative taper-timing, then the outlook for CPI inflation could be pushed below the BoE’s target rate over the medium-term. This would appear to run contrary to the BoE’s risk management approach to oppose weakness in the economy being “amplified by a tightening in monetary conditions that could slow the return of inflation to the target”. We had been expecting an extension of the QE envelope in May (by £75bn) for precisely this reason, but with the BoE clearly preferring a cautious approach in the face of uncertainty, the odds of a May QE increase appear reduced. However, a further tightening in financial conditions and particularly sterling, could yet lead to such a modest fine-tune to QE to keep BoE operations in line with other major central banks.

Financial markets reacted to the BoE’s meeting. 2-year and 10-year gilt yields eased modestly after the meeting – 2-year yields dipped 2bps to 0.10% and the 10-year yield was down just 1bps to 0.89%. Both are materially higher at 11-month and 22-month highs respectively. Relatedly, sterling eased back by 0.25% to the Euro at £0.857 and 0.4% to the US dollar at $1.91.