The positive news on vaccines meant that the Monetary Policy Committee (MPC) didn’t feel the need to loosen policy any further at its December meeting today. And, as long as there is a Brexit deal by 31st December 2020, we don’t think it will need to loosen policy next year either. But if there is a no deal Brexit, the MPC may find its Christmas dinner has turned into a working lunch.
- The positive news on vaccines meant that the Monetary Policy Committee (MPC) didn’t feel the need to loosen policy any further at its December meeting today. And, as long as there is a Brexit deal by 31st December 2020, we don’t think it will need to loosen policy next year either. But if there is a no deal Brexit, the MPC may find its Christmas dinner has turned into a working lunch.
- As expected by us and the consensus, all nine Committee members voted to keep interest rates on hold at +0.10% and the Quantitative Easing (QE) target at £895bn. Much like Fed, the Bank does not appear to be on the cusp of revising its GDP forecasts higher. However, while the Fed did not even acknowledge the boost vaccines had given to the economic outlook, the MPC at least commented that the successful rollout of the vaccine had reduced the downsides risks to the economy it had highlighted in November. But this was caveated by it saying “Although all members agreed that this would reduce downside risks, they placed different weights on the degree to which this was also expected to lead to stronger GDP growth in the central case.” So, while the vaccine is a positive development, in the eyes of the MPC at least, the economy is far from out of the woods. As a result of these continued concerns, the MPC voted to extend the availability of the Term Funding Scheme with additional incentives for SMEs (TFSME) for six months from 30th April until 31st October 2021.
- The Bank reiterated that its forecasts are based on a situation where “the United Kingdom left the Single Market and Customs Union on 1 January 2021 and was assumed to move immediately to a free trade agreement with the European Union.” If there isn’t a Brexit deal, then the MPC would probably call an emergency meeting rather than waiting until its next scheduled meeting on Thursday 4th February 2021 before taking action. The MPC also said that given that “the economy was starting from a weaker position with greater spare capacity”, the Committee would have an increased tolerance for a temporary overshoot in inflation. This is the MPC saying that if there is a no deal, rather than worrying about the rise in inflation from a weaker pound, it would most probably loosen policy to support the real economy.
- But even then, we doubt the Bank would rush to implement negative interest rates or announce another round of gilt purchases (it isn’t planning to start buying the batch it announced in November until 2021). Instead, it’s more likely to speed up the pace of gilt purchases from £4bn a week currently, buy more corporate bonds, expand its lending facilities or strengthen its forward guidance that it is willing to take whatever action is necessary to achieve its remit.
- And even assuming there is a Brexit Christmas miracle, the MPC said risk management considerations implied that policy should lean strongly against downside risks to the outlook. So the MPC may still decide to loosen policy at some point. But we think that the economy will recover considerably faster in 2021 than the MPC does, meaning that it won’t have to loosen policy further. (See Chart 1.) But with the MPC today repeating the guidance that it won’t tighten policy “until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target sustainably”, it will be a long time before it tightens policy either. Indeed, in contrast to the market, we expect interest rates to stay at 0.10% for the next five years. (See Chart 2.)
Chart 1: Real GDP (Q4 2019 = 100)
Chart 2: Expectations for Bank Rate (%)
Sources: BoE, OBR, Capital Economics
Sources: Refinitiv, Capital Economics
Thomas Pugh, UK Economist, +44 (0)7568 378 042, email@example.com