MPC not ready to use negative rates…and may not need to - Capital Economics
UK Economics

MPC not ready to use negative rates…and may not need to

UK Economics Update
Written by Paul Dales
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Our forecasts that the Bank of England would not be able to use negative interest until the middle of the year and wouldn’t be willing to speed up the pace of its quantitative easing (QE) proved to be spot on today. And the more optimistic feel of the Monetary Policy Committee’s latest economic forecasts lends some support to our view that the MPC won’t actually cut rates below zero this year or next.

 

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  • Our forecasts that the Bank of England would not be able to use negative interest until the middle of the year and wouldn’t be willing to speed up the pace of its quantitative easing (QE) proved to be spot on today. And the more optimistic feel of the Monetary Policy Committee’s latest economic forecasts lends some support to our view that the MPC won’t actually cut rates below zero this year or next.
  • While unanimously voting to leave interest rates at +0.10% and the stock of quantitative easing (QE) at £895bn today, the MPC essentially ruled out using negative interest rates for at least another six months because financial firms were not ready to implement them. But the Bank has told financial firms to start preparing so that they could “implement a negative Bank Rate at any point after six months”. This will have disappointed some analysts who had thought that the Bank would say negative rates could be used from today, but it is exactly in line with the timetable we had suggested. (See here.) That explains the rise in market rate expectations and 7 bps gain in 2-year gilt yields since today’s announcement. (See Chart 1.)
  • And the MPC said this “should not be interpreted as a signal that the setting of a negative Bank Rate…was imminent, or indeed in prospect at any time”. And there were few other signs that the MPC thought that in six months’ time it would need to use negative rates or provide other extra support.
  • Indeed, it wasn’t a surprise that the MPC didn’t launch more QE when it has only done £16bn of the £150bn of extra QE launched in November. And by repeating that it expected those purchases to be completed “around the end of 2021”, the MPC implied that the pace of QE will be slowed at some point. If not, at the current pace of £4.4bn a week, the £150bn will be completed by end-August. Some analysts had expected the MPC to quicken the QE pace to support the economy. But as we had pointed out, the MPC typically uses the pace of QE to tackle liquidity problems in the market, of which there are none. (See here.)
  • What’s more, on the whole the new MPC’s economic forecasts looked a bit more optimistic. Admittedly, the current COVID-19 lockdown meant that the Bank revised down its forecast for Q1 GDP to a 4% q/q fall. But the rebound from Q2 was revised up to leave GDP getting back to its pre-crisis peak in Q1 2022 – the same as in November’s forecasts. And while the unemployment rate was still expected to rise from 5.0% in November to a peak of 7.8%, the Bank projected that economic demand would rise above supply in Q1 2022, which was a bit earlier than before. That explains the upward revision to the CPI inflation forecast, which is now above 2% from the second half of 2022 until Q1 2024.
  • Of course, the Bank is not itching to tighten policy. The MPC again said that it won’t do that until it is “achieving the 2% inflation target sustainability”. That means it’s not enough for it to forecast inflation rising and staying above 2%, it needs to see that actually happen. That suggests to us the Bank won’t raise interest rates above +0.10% for another five years yet (although the Bank has started work reconsidering its previous stance that when the time comes to tighten policy it would raise rates to 1.5% before unwinding QE).
  • Our own GDP forecasts are a bit more upbeat than the Bank’s beyond the next 18 months. (See Chart 2.) That’s why we aren’t expecting the MPC to increase QE or use negative interest rates in either 2021 or 2022. 10-year gilt yields have already risen by 8 bps today. But if the markets continue to come round to our view, they may yet rise from 0.44% now to 0.50% by the end of the year.

Chart 1: Bank Rate Expectations (%)

Chart 2: Real GDP (Q4 2019 = 100)

Sources: Refinitiv, Capital Economics

Sources: Bank of England, Capital Economics


Paul Dales, Chief UK Economist, +44 (0)7939 609 818, paul.dales@capitaleconomics.com