BoE extends stimulus, QE rises by £150bn

The Bank of England today announced that it would extend its gilt asset purchases by £150bn, taking the total to £875bn. This was more than our forecast of £100bn. The decision was taken unanimously. It also announced that it would leave Bank Rate at 0.1% and the corporate bond asset purchases unchanged, both by unanimous agreement. The Bank also published minutes to the meeting and its Monetary Policy Report. The Monetary Policy Report, conditioned on government restrictions announced up to 31 October and expectations of a free trade deal being announced between the UK and EU before the end of transition on 31 December, saw a downward revision to the BoE’s growth forecasts and saw risks to this outlook skewed to the downside. However, CPI inflation expectations were revised higher, with inflation now expected to return to target next year, with risks around this outlook seen as balanced.

The Monetary Policy Report set out the Bank of England’s revised GDP outlook. With the re-emergence of the virus, the Bank reported a softening in consumer conditions already apparent, before the resumption of the ‘time-limited’ lockdown imposed by the government on 31 October. Reflecting these developments, the BoE warned that growth in Q4 would contract, pencilling in a fall of 2.5% in Q4. It also downgraded its outlook to Q3 GDP by over 2ppt to 16.1% qoq. Combined, this reduced the BoE forecasts for GDP growth this year to -11% from -9½% in August. The BoE also lowered its forecast for GDP growth in 2021 to 7¼% (from 9%), but raised its outlook for 2022 to 6¼% (from 3½%) and initiated an outlook of 1¾% growth for 2023. The Bank considers the risks to its GDP outlook to be skewed to the downside. So do we. While material uncertainty surrounds the impact of the latest round of lockdown, we consider the likelihood of a somewhat sharper drop in Q4. We are also less convinced about the scale of rebound in Q1, pencilling in a cautious rebound in Q1 including an adverse effect on UK GDP growth from the shift out of the EU-exit transition phase. We also expect a firmer growth outlook beyond Q1 2021, which we hope will begin to reflect the impact of a vaccine roll-out across the UK, but again are cautious and consider growth likely below the BoE’s current 7.25% for next year.

Despite the significant lowering of the Bank’s GDP forecasts, its estimation of the impact on excess demand in the economy is adjusted by a smaller amount, just 0.25ppt lower in 2020 and 1ppt lower in 2021 to be basically unchanged (¼ ppt lower) in 2022. This marks a significant increase in pessimism from the BoE on the permanent impact of the pandemic on the UK economy – even as it incorporates more optimistic forecasts than our own on the pace of economic rebound. Accordingly, based on market rate expectations, the BoE raised its outlook for CPI inflation to ½% from a forecast ¼% in August, based on actual price behaviour across most of this year and to 2% (from 1¾% in August) for next year, where it forecasts inflation to remain for 2022 and 2023. Forecasts were 1.5% for 2021, 1.9% for 2022 and 1.9% for 2023 based on a constant policy assumption. The Bank also considers the risks around these forecasts balanced. While we fully recognise the risk of supply damage to the UK economy from the pandemic and from Brexit, we consider the risks to the BoE’s forecasts as skewed lower. Indeed, today’s minutes discuss “material spare capacity” in the economy, point to “weak” wage growth including “pay freezes and outright cuts” and discuss a risk of “a more persistent period of elevated unemployment”. Minutes also consider subdued rents from commercial property, specifically office and retail space, as something that could feed through to lower prices. Headline inflation is set to rebound sharply next year on the energy price and VAT cut reversals. However, we fear the underlying pace of price growth will be more subdued and continue to forecast inflation below 2% in 2021 and 2022.

Based on the Bank’s current assumptions, today’s policy actions will be sufficient to restore the UK inflation profile to target over the target horizon. Indeed, with the £150bn extension of QE announced today, the Bank can maintain the current pace of purchase through until August next year. However, with the Bank of England considering risks skewed to the downside for its outlook and our own expectation that growth and inflation look set to be lower than the BoE currently projects, we see the case for more stimulus as likely over the course of next year. Of course, it is not solely down to the BoE to provide economic support and as the UK economy hopefully emerges from the current round of COVID restrictions, we expect Chancellor Rishi Sunak to provide more stimulus, albeit likely as part of Spring Budget. Nevertheless, an undershoot of the inflation target is likely to make the case for more monetary policy support in 2021, even as we expect growth to begin to recover. For now we pencil in a further more modest extension of QE, a further £75bn, in May 2021. The debate is likely to persist about the prospect of negative rates in the UK economy – not least with the Bank’s current forecasts conditioned on market assumptions of Bank Rate at -0.1% over the coming years. We continue to believe that the prospect of Bank Rate below zero is unlikely but consider the possibility that the Bank can facilitate other means to deliver negative market rates (through adjusting the TFSME scheme similar to the ECB’s use of sub deposit rate TLTRO funding). However, there does not seem to be any consensus for this on the Committee at present. Moreover, there was a noteworthy lack of comment about the issue in today’s minutes. Accordingly, and as we hope the UK economy will be passing the nadir by next year, we doubt the MPC will actually undertake this more unconventional approach, relying for further stimulus once more on QE.