UK Reaction: BoE leaves policy unchanged - assessment to be made "over longer period of time"
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, Bank Rate at 0.10%, and the Asset Purchase Facility at £895bn, with purchases expected to finish around end-2021.
- BoE Chief Economist Haldane voted to reduce the BoE’s QE target by £50bn at this meeting.
- While we acknowledged risks, Haldane’s single dissent looks more to do with his leaving the MPC after this meeting, than the appropriate time for a shift in policy.
- The MPC revised its GDP outlook for Q2 higher to 5.5% from 4.25%. It also now expects inflation to peak over 3% for a brief period.
- Yet its medium-term assessment is more sanguine, expecting supply and demand to be in balance and seeing inflation expectations well-anchored.
- We continue to see modestly slower GDP growth and lower CPI inflation than BoE forecasts. As such we expect the BoE to leave policy on hold until Q3 2023.
- Market expectation is for a quicker tightening, although today’s announcement has seen expectations for the first hike slip back into 2023 from late-2022.
The Bank of England voted unanimously to leave Bank Rate unchanged at 0.10% in June and corporate bond holdings at £20bn. The Committee voted 8-1 in favour of leaving the gilt component of QE unchanged at £875bn. Chief Economist Haldane once again voted to reduce this by £50bn. Yet beyond that the Committee seemed in no rush to shift the policy outlook. This was in line with our expectation, but appeared to be less hawkish than markets had expected.
The BoE did not provide new medium-term forecasts at this meeting, but reviewed developments since May. It revised its outlook for Q2 GDP higher to 5.5% from 4.25% in May, largely on the back of stronger growth in April. It also noted that CHAPS payments data pointed to a more stable outlook for retail spending into early June after the 9% surge seen in April. In total, the BoE noted that total UK output should be 2.5% lower than the pre-COVID level by the end of Q2. The BoE stated that it was uncertain whether the faster expansion in Q2 reflected stronger expansion, or a faster rebound to pre-COVID levels. It added that the push-back in easing of final COVID restrictions to 19 July was likely to have only a “small” impact on activity, but acknowledged downside risks from “increased caution following a further rise in cases” as well as concerns about virus mutations. Finally, the BoE also noted mixed messages from the labour market, including some signs of recruitment difficulty, but that the recent fall in unemployment reflected a rise in “economic inactivity” and that it was unclear if and how quickly this drop in labour market participation might unwind.
Minutes to June’s meeting showed that the MPC spent a lot of time focusing on price developments. The MPC clearly focused on the rise in international prices and discussed the sharp shift in demand for goods, rising commodity prices, supply-side constraints and bottlenecks, but concluded that it considered these developments to be “transitory”. That said, the recent rise in inflation to 2.1% had exceeded previous BoE forecasts by 0.3ppt and the BoE revised its outlook for the peak in the transitory inflation spike to “exceed 3% for a brief period”. This is broadly consistent with our own outlook that CPI inflation looks set to peak in Q4 this year at around 3%.
In the short-term, we concur with BoE forecasts. We see GDP growth rising by 5% in Q2, before we think slowing in H2, in part reflecting concerns over the virus and furlough. And that we forecast CPI inflation to rise to around 3% in Q4, before falling back modestly below the 2% inflation target (just above 1.50%) next year. The BoE stated both that policy should “lean strongly against downside risks and ensure that the recovery was not undermined by a premature tightening in monetary conditions” and that policy would not be tightened before “clear evidence of significant progress to eliminate spare capacity and achieve the 2% inflation target sustainably”. As such, we see no near-term impetus to adjust monetary policy. The accompanying minutes to this month’s meeting seemed to suggest as much stating that one view saw an assessment over “a somewhat longer period of time” crucially to judge the wider labour market implications once furlough has ended. One member clearly disagreed with that view, but we suspect that Chief Economist Haldane’s assessment to reduce policy accommodation now was more a factor of this being his last MPC meeting, more than the appropriateness of the change in policy.
The BoE states that longer-term monetary policy will be based on the medium-term balance of supply and demand and inflation expectations, rather than transient factors. The BoE’s own assessment is that beyond a temporary period of excess demand, demand and supply should be broadly in balance and that inflation expectations remained well-anchored. Our longer-term assessment is that UK GDP growth will be a little softer than the BoE expects, we forecast 6.8% now versus BoE forecasts of 7.25% in May and that inflation will fall back a little more than the BoE expected, we forecast above 1.5% by end next year, rather than around 2%. Accordingly, we suspect that the BoE will take slightly longer to tighten monetary policy than current expectations, which rose after last week’s Fed meeting. We forecast a rise to 0.25% in August 2023. Part of that assessment reflects an expectation for a broader tightening in financial conditions with international and domestic yields likely to rise further over the coming quarters and sterling firmer (trade-weighted already 1% higher than in May). However, with significant uncertainty surrounding the growth outlook, we also add that if the UK recovery continues to run ahead of our expectations, the risks appear skewed to a sooner than later hike than our current expectations.
Markets reacted dovishly to today’s release, consistent with our own view that the BoE will ultimately take longer to raise interest rates than previously considered. Short-sterling futures now suggest the first rise to 0.25% only in early 2023 (from late 2022) and a further hike towards end-2023, rather than around mid-year. Accordingly, gilt yields dropped, the 2-year down 3bps to 0.07% and 10 year down 4bps to 0.74%. Sterling also dipped by 0.4% to the US dollar (to $1.392) and 0.5% to the euro to £0.858. This helped the FTSE 100 index make gains of 0.2% after the announcement.