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UK Reaction: Policy and outlook on hold in face of delta

David Page, Head of Macro Research at AXA Investment Managers, comments on the Bank of England’s latest Monetary Policy Committee:

 

  • BoE leaves monetary policy unchanged, although Saunders votes to end QE early as threatened in recent speech.
  • The BoE acknowledges downside growth risks near-term, but edges forecasts higher for 2022 and 2023.
  • Inflation is now forecast to peak at 4% in Q4 2021, before returning back to 2% in around two years’ time, confirming the Bank’s view that the current inflation pressures are transitory.
  • Medium-term risks reflect rising inflation expectations – which remain well anchored for now – and labour market tightness.
  • We still expect Bank Rate to remain on hold through 2022, but markets now price Bank Rate to reach 0.50% by Q1 2023. If GDP is firmer than we forecast, rates should begin to rise next year.
  • The Bank also changed its sequencing of policy tightening, suggesting it would unwind QE when Bank Rate reached 0.5%, down from 1.5% previously.

 

The Bank of England’s (BoE) Monetary Policy Committee (MPC) left policy unchanged as was widely expected after today’s meeting. Bank Rate remained at 0.1% and the Asset Purchase (QE) Facility was unchanged at £895 billion (£875 billion gilts and £20billion corporate bonds). The Committee voted unanimously to leave rates on hold, but voted 7-1 to leave QE unchanged, with external member Michael Saunders following up on a speech given in recent weeks where he suggested he would vote to end QE early. Deputy Governor Dave Ramsden, who had given a hawkish speech at the same time, did not vote to end QE early as some in markets had suggested he might. Both outcome and votes were in line with our expectations, and broadly in line with consensus market expectations.

Governor Bailey aptly remarked that there had been relatively few developments in the economic outlook since May. The BoE still considered Q2 GDP likely to rise by 5% on the quarter, although noted that it had lowered its Q3 outlook to 3% from 4%, with the impact of revived delta-COVID cases weighing on the UK and global economies. However, the BoE still looked for relatively robust growth of 2% in Q4, leaving GDP growth at 7.25% for 2021 as a whole, before slowing quickly back to trend rates across 2022 – albeit with growth in that year forecast at an upward revised 6% (from 5.75%) in 2022 and 1.5% (from 1.25%) in 2023. The minutes also described a labour market with nearly 2 million more identified as not in employment through a combination of raised unemployment, furlough and inactivity. That said, the BoE’s near-term concerns appeared to have shifted more towards one of labour market shortage – at least in the near-term – than oversupply. The BoE considered “a period” of excess demand likely, reflecting short-term supply constraints, but thought that in the medium-term supply constraint, including in the labour market, should ease, bring conditions of supply and demand back into balance across 2022 and into 2023.

Inflation has developed further. The BoE noted that June’s inflation at 2.5% was 0.8ppt higher than expected in May and that the BoE now expected inflation to peak at around 4% in Q4 2021, up from just over 3% in May. However, the Committee went into some detail to explain why they considered to expect this to be a transitory surge. First, the BoE suggested that there were already some signs of an easing in supply-side constraints. Second, that they expected demand for goods to subside relative to demand for goods, again suggesting that in the UK this process was already underway. The Bank forecast inflation to be at 2.25% in 2 years’ time and 2.10% in 3 years’ time, even if there were no policy changes over the forecast horizon. However, as the minutes noted that “all members” considered some policy tightening over the forecast horizon, the inflation forecast was 2.1% and 1.9% at 2-year and 3-year horizons assuming that rates were broadly around 0.25% in 2022 and 0.50% in 2023 – as the BoE inferred was priced by the curve. That said, Governor Bailey bridled at the suggestion of complacency in the press conference. The MPC does consider two broad sets of risks, the first reflecting any upward rise in medium-term inflation expectations – for now the Committee is satisfied that such expectations remain “well anchored”. The second the labour market developments. Here as well as the uneven pace of recovery, the BoE must add in the longer-term supply shock of Brexit and how this will reduce labour supply over the coming years.

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