UK Reaction: MPC sits tight amidst “unusual” uncertainty

• The Bank of England left monetary policy on hold, as fully expected, including Bank Rate, gilt and corporate bond QE purchases.
• The Bank did extend the drawdown period of the TFSME programme by 6 months to 31 October 2021 at today’s meeting.
• Minutes showed a Committee considering “unusual uncertainty” amidst the pandemic, the possible impact of the virus and Brexit.
• With that in mind, the minutes shed little light over any future policy debate. And said nothing about negative interest rates.
• We continue to anticipate a further extension of QE next year (May), and the BoE to avoid taking the policy rate into negative territory.

The Bank of England’s (BoE) Monetary Policy Committee (MPC) had extended its QE programme by £150bn last month, expecting purchases through until the end of next year. As such, the BoE was not expected to change policy again this month and in that they delivered. The MPC voted unanimously to leave the Bank Rate unchanged at 0.10%, the corporate bond purchase programme unchanged at £20bn and the gilt purchase programme unchanged at £875bn. The Committee did, however, extend the drawdown period of the Term Funding Scheme for Small and Medium-sized Enterprises (TFSME) by 6 months to 31 October 2021.

Minutes of the meeting showed a Committee understandably racked by “unusual uncertainty” about the outlook. The Committee discussed the uncertainties associated with the pandemic, the vaccine and the impending departure from EU trading conditions, into what the BoE continues to assume will be a comprehensive free trade agreement. Such are the scale of uncertainties, that the BoE described the “near-term UK outlook” as having “evolved broadly in line with the Committee’s expectations in the November Report”. The text went on to explain that actually the 0.4% rise in October’s GDP had been “significantly above expectations at the time of the November Report". Indeed, the BoE now forecasts Q4 GDP to contract by a little over 1%, compared to a projected fall of 2.5% in November. The change in the forecast assumption for Q4 alone was around the same size of total economic expansion across 2019. But such are the times we live in that such swings in GDP and projections are commonplace. The minutes also stated that the more upbeat prospect of a vaccine for 2021 was fraught with uncertainty, reporting a “range of views” across the Committee on the extent to which it would reduce downside risks over the coming year and “different weights” on the “degree to which it could be expected to lead to stronger GDP growth”.

The Committee did note that after Q3’s GDP release the UK economy remained 10% smaller than its pre-Covid, end-2019 level. It stated that consumption was 13% lower, with consumer services -17%, but consumer goods also -4% and at odds with retail and car sales data. The minutes also reported that business investment, which it said had rebounded by more than expected, was 20% lower and the outlook would be hindered going forwards by uncertainty over the priority firms placed on balance sheet repair over additional spending looking ahead and uncertainties related to Brexit. The minutes additionally noted that only 70% of UK firms reported themselves ready – or as ready as they can be – for new trading conditions. A significant minority was described as not fully ready, with the MPC concluding that “at least some short term disruption appeared likely” as the UK left EU trading arrangements on 1 January 2021.     

The Committee discussed why the UK appeared to have suffered a larger drop in output than the US or larger European economies. Qualitatively, the minutes discussed the prevalence of the virus; the measurement of health and education services in the UK; a faster drop in consumer spending on social activities; and a relatively slower pick-up in mobility which it suggested reflected a slower return to the work place, in turn plausibly a product of large scale public transport usage in commuting, particularly to London.

Yet the minutes reported relatively little discussion around policy itself. The minutes recorded that “At this meeting, all members of the Committee judged that the existing stance of monetary policy remained appropriate". The minutes added that the Committee would continue “to monitor the situation closely” and stood “ready to take further action” if necessary. The Committee also added its own brand of forward guidance, stating that it would not tighten monetary policy until “there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably”. Beyond that there was little suggestion of any broader consideration of policy change. There remains no reference to considering negative interest rates at any point.

We have sympathy with the Committee’s outlook and readily acknowledge elevated uncertainty. To our minds, the MPC’s November forecast for GDP growth to rise in excess of 7% next year will likely prove too optimistic. We assume some Brexit transition disruption reducing GDP in H1 2021, despite expecting a trade deal to be announced over the coming days. Moreover, while mindful of a firmer Q4 than we had expected a month ago, the prospect of further material virus related restrictions weighing into the early months of 2021 are uppermost on our minds. We continue to forecast growth of just 4.6% in 2021, although acknowledge some upside risks here following firmer GDP in October. We think that this will reduce the likelihood of returning CPI inflation sustainably to target over the next couple of years. As such, we expect more monetary policy stimulus from the BoE. However, we do not believe that the MPC as a whole is convinced about the net merits of reducing Bank Rate further, let alone into negative territory. Rather, we expect the MPC to further extend QE in Q2 2021, taking asset purchases into 2022, in line with our expectations for the ECB and Fed.

Financial market reaction to today’s announcement was negligible. Neither the 2-year nor 10-year gilt yields recorded a material change, remaining at -0.08% and 0.27% respectively. Sterling dipped a little to both the US dollar (-0.1%) and the euro (-0.2%), although this was just as likely on the latest statement from the Prime Minister’s spokesman that “no deal” still look most likely. And the 0.1% rise in the FTSE 100 looks a consequence of sterling moves. Indeed, with the BoE fulfilling expectations of no change and suggesting no obvious policy steer amidst heightened uncertainty, we will join markets in awaiting the outcome of significant developments before the February Monetary Policy meeting before reviewing our expectations for future BoE policy.