Negative rates on the table, but BoE not reaching for them - Capital Economics
UK Economics

Negative rates on the table, but BoE not reaching for them

UK Economics Weekly
Written by Thomas Pugh
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The MPC played down the prospects of negative interest rates anytime soon at its meeting this week and instead suggested that it would use the other tools in its arsenal such as forward guidance and QE. That’s in line with our view that interest rates will remain lower for longer and that much more QE is on the way than the market expects.

Interest rates lower for longer

The Monetary Policy Committee (MPC) could have saved itself some time and just read our UK Economics Focus, published on 4th June, or our UK Economics Update, published 14th May, both of which came to much the same conclusion about negative interest rates as the MPC did in this week’s Monetary Policy Report (MPR)!

In a four-page box in the MPR, the MPC made clear that although negative interest rates were an option, it had no plans to use them anytime soon. It suggested that while negative rates can work in some circumstances, it would be “less effective as a tool to stimulate the economy” at this time when banks are worried about future loan losses. And that it has “other instruments available”, including QE and forward guidance.

Chart 1: Restaurant Bookings (% y/y)

Source: Open Table

As we expected, the MPC did dabble in a little bit of forward guidance saying that “it does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% target sustainably”. (See here.)

Bank watchers could be forgiven for wondering why the MPC was even talking about tightening at all! Admittedly, if the number of people dining out in August is anything to go by, then the MPC will have to start thinking about tightening policy pretty sharpish! (See Chart 1.) But we think this says more about Britons’ willingness to risk life and limb for a bargain (the “Eat Out to Help Out” scheme offers up to £10pp off meals out Monday – Wednesday) than it does about the economic recovery.

Instead, the MPC’s new phrase was designed to dilute the message from the more positive set of forecasts in the MPR and show that even though it expects inflation to rise to 2%, the MPC won’t tighten policy. (See here.) Crucially, though, we don’t think this implies that the MPC would be prepared to tolerate a period of above-target inflation when the economy recovers, as the Fed has implied that it might do. Instead, given the huge amount of uncertainty around the forecasts, it’s more about the MPC wanting to see actual inflation around 2.0% before acting.

The market has taken the MPC’s message to mean that there is less chance of negative interest rates in the short term, but that interest rates will stay lower for longer. (See Chart 2.) We’ve been saying that since May too. (See here.)

Chart 2: Interest Rate Expectations (%)

Sources: Refinitiv, Capital Economics

Overall, we are happy with our view that the MPC will expand QE by a further £250bn in total by the end of 2021, and that it will keep interest rates at +0.10% or below for at least five years. That amount of QE is much more than other forecasters expect.

The week ahead

The labour market data for June (due on Tuesday) will probably show that unemployment continued to rise, despite the GDP data for the same month (due on Wednesday) probably revealing the first meaningful rebound in activity.


Data Previews

Labour Market (Jun./Jul.) Tue. 11th Aug.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Employment (3m/3m, Jun.)

07.00

-126,000

-280,000

-280,000

Claimant Count (m/m, Jul.)

07.00

-28,100

-30,000

ILO Unemployment rate (Jun.)

07.00

3.9%

4.1%

4.1%

Av. Earnings (inc. bonuses, mm, 3m/yy, Jun.)

07.00

+0.2(-0.3%)

-0.2%(-1.2%)

-0.8%(-1.4%)

Rise in inactivity probably limited the increase in unemployment

A rise in inactivity has probably limited the increase in unemployment so far, but bigger rises lie ahead.

The number of employees paid through PAYE fell by 74,000 m/m in June. This points to a 280,000 drop in the headline measure of employment, which compares average employment in April to June to the previous three months. (See Chart 3.)

But with new vacancies plunging, we think that half of the people who lost their job became inactive (i.e. they stopped looking for work). That may have limited the rise in unemployment to 45,000 in the three months to June and caused the unemployment rate to rise only slightly, from 3.9% to 4.1%. We expect the claimant count to tick down again in July, perhaps by a further 30,000. That would take the claimant count rate down from 7.3% to 7.2%.

Meanwhile, lower bonuses and the pay cuts of many workers on the furlough scheme probably pushed pay growth down further in June. We have pencilled in a 0.8% m/m fall in total pay, which would drag down headline annual growth from -0.3% to -1.4%.

Chart 3: LFS Employment

Sources: Refinitiv, Capital Economics

Monthly GDP & Services Output (Jul.) Wed. 12th Aug.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Monthly GDP m/m(%y/y)

07.00

+1.8%(-24.0%)

+8.0%(-18.1%)

+7.5%(-18.5%)

Services Output m/m(%y/y)

07.00

+0.9%(-23.6%)

+7.5%(-18.0%)

+6.5%(-19.0%)

Slowly regaining the lost ground

Our estimate that GDP rose by around 7.5% m/m in June would mean that it fell by 23.1% q/q in Q2 as a whole and was still about 19% below its pre-crisis level at the end of June.

Our CE BICS Indicator, which we derive from a ONS fortnightly survey on business turnover (see here), suggests that the disappointing 1.8% m/m rise in GDP in May was followed by a bigger increase of about 7.5% m/m in June. (See Chart 4.) That may have been due to a 15% m/m gain in construction output and a 10% m/m rise in industrial production (see the preview below), while lockdown restrictions restrained services output to a 6.5% m/m rise.

The CE BICS Indicator implies that GDP rose at only a slightly slower pace in July. Even so, by the start of August GDP may still have been between 10% and 15% below pre-crisis levels. (See Chart 4 again.)

Chart 4: CE BICS Indicator & GDP

Sources: Refinitiv, ONS, Capital Economics

Industrial Production (Jun.) Wed. 12th Aug.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Manufacturing Output m/m(y/y)

07.00

+8.4%(-22.8%)

+9.9%(-12.1%)

+10.0%(-15.0%)

Industrial Production m/m(y/y)

07.00

+6.0%(-20.0%)

+9.7%(-12.9%)

+8.2%(-13.4%)

Recovery in industrial production continues

The recovery in industry appears to have made further progress in June, reflecting the sectors resilience to social distancing restrictions compared to many services sectors.

Manufacturing was a bright spot in the May GDP figures, growing by 8.4% m/m while the total economy expanded by just 1.8% m/m. That left industrial production 19.1% below its pre-virus level compared to a peak-to-trough fall of 23.6%.

The sector made up more of the lost ground in June. The ONS Business Impact of Coronavirus survey shows that almost all manufacturing firms were open by June, up from 94% in May. And after stopping almost entirely in April, car production recovered to a half of pre-virus levels in June. (See Chart 5.) That alone will raise manufacturing output by about 4% m/m. We have pencilled in a 10% m/m increase in manufacturing output overall.

Meanwhile, electricity and gas usage data suggest that utilities output rose by about 3% m/m. That points to an 8.2% m/m increase in industrial output overall, which would leave it 13.4% below its pre-virus level. The rise in the manufacturing output PMI to a three-year high in July suggests the sector has continued to recover since June too.

Chart 5: SMMT & ONS Car Production

Sources: Refinitiv, Capital Economics

International Trade (Jun.) Wed. 12th Aug.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

Trade in Goods & Services Balance

07.00

+£4.3bn

+£2.7bn

+£5.0bn

Net trade to support GDP this year

Trade volumes may have recovered a little more in June as lockdowns were eased both domestically and internationally.

Export volumes began to recover in May, rising by 3.8% m/m. But imports volumes remained depressed, falling by another 1.5% m/m as most of the UK economy remained in lockdown.

The rebound in export volumes in likely to have continued in June as the UK’s main trading partners recovered. The export orders balance of the IHS Markit/CIPS manufacturing PMI suggests that goods export volumes rose rapidly. (See Chart 6.) Admittedly, the PMI overstated the downturn and so is probably overstating the upturn. So we have pencilled in a 5% m/m increase.

The easing of lockdown in the UK probably boosted imports by about 5% m/m in June as well. Indeed, timely shipping data show that cargo and tanker ship visits to UK ports were up by 10% m/m in June.

As a result, the trade surplus probably rose from £4.3bn in May to £5.0bn in June. As the UK is recovering slower than most other countries, net trade may offer a welcome boost to activity in the months ahead.

Chart 6: Manufacturing PMI & Export Volumes

Sources: Refinitiv, IHS Markit


Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 10th

No Significant Data Released

Tue 11th

UK

BRC Retail Sales Monitor (Jul)

(00.01)

(+10.9%)

UK

Change in Employment (Jun, 3m/3m)

(07.00)

-126,000

-280,000

-280,000

DR

UK

ILO Unemployment Rate (Jun)

(07.00)

3.9%

4.1%

4.1%

DR

UK

Average Earnings Inc. Bonus (Jun, m/m(3m y/y))

(07.00)

+0.2%(-0.3%)

(-1.2%)

-0.8%(-1.4%)

DR

UK

Average Earnings Ex. Bonus (Jun, m/m(3m y/y))

(07.00)

+0.2%(+0.7%)

(-0.1%)

-1.0%(-0.5%)

DR

UK

Claimant Count Rate (Jul)

(07.00)

+7.3%

+7.2%

DR

UK

Claimant Count (Jul)

(07.00)

-28,100

-30,000

DR

Wed 12th

UK

GDP (Q2, Prov., q/q(y/y))

(07.00)

-2.2%(-1.7%)

-21.3%(-22.6%)

-21.3%(-22.6%)

DR

UK

GDP (Jun)

(07.00)

+1.8%(-24.0%)

+8.0%(-18.1%)

+7.5%(-18.5%)

DR

UK

Services Output (Jun)

(07.00)

+0.9%(-23.6%)

+7.5%(-18.0%)

+6.5%(-19.0%)

DR

UK

Industrial Production (Jun)

(07.00)

+6.0%(-20.0%)

+9.7%(-12.9%)

+8.2%(-13.4%)

DR

UK

Manufacturing Output (Jun)

(07.00)

+8.4%(-22.8%)

+9.9%(-12.1%)

+10.0%(-15.0%)

DR

UK

Construction Output (Jun)

(07.00)

+8.2%(-39.7%)

+14.2%(-30.0%)

+15.0%(-29.5%)

DR

UK

Trade Balance (Jun)

(07.00)

+£4.3bn

+£2.7bn

+£5.0bn

DR

UK

Productivity (Q2, Prov., q/q(y/y))

(07.00)

-0.3%(-0.6%)

DR

Thu 13th

UK

RICS Past House Price Balance (Jul)

(00.01)

-15%

DR

UK

Mortgage Arrears (Q2)

72,380

Fri 14th

No Significant Data Released

Selected future data releases and events

Wed 19th

UK

CPI (Jul)

(07.00)

DR

UK

Core CPI (Jul)

(07.00)

DR

Fri 21st

UK

Public Finances (Jul)

(07.00)

DR

UK

Retail Sales Inc. Fuel (Jul)

(07.00)

DR

UK

IHS Markit/CIPS Composite PMI (Aug, Flash)

(09.30)

DR

UK

IHS Markit/CIPS Services PMI (Aug, Flash)

(09.30)

DR

UK

IHS Markit/CIPS Manufacturing PMI (Aug, Flash)

(09.30)

DR

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts*

%q/q(%y/y) unless stated

Latest

Q1 2020

Q2 2020

Q3 2020

Q4 2020

2019

2020

2021

2022

GDP

-2.2(-1.7) (Q1)

-2.2(-1.7)

-21.3(-22.6)

+14.2(-12.3)

+5.2(-7.7)

(+1.5)

(-11.0)

(+9.5)

(+3.3)

CPI inflation

(+0.6) (Jun.)

(+1.7)

(+0.6)

(-0.1)

(+0.2)

(+1.8)

(+0.6)

(+1.2)

(+1.3)

ILO unemployment rate (%)

3.9 (May)

3.9

4.1

5.5

6.4

3.8

5.0

6.7

5.5

Bank rate, end period (%)

+0.10

+0.10

+0.10

+0.10

+0.10

+0.75

+0.10

+0.10

+0.10

10 yr gilt, end period (%)

0.11

0.36

0.17

0.17

0.25

0.83

0.25

0.25

0.25

$/£, end period

1.31

1.24

1.25

1.30

1.35

1.33

1.35

1.35

1.35

Euro/£, end period

1.11

1.14

1.11

1.12

1.13

1.18

1.13

1.13

1.13

Sources: Capital Economics, Refinitiv

* Assumes the UK and the EU agree a slim trade in goods deal by the end of the year, with the status quo for services and financial services maintained until a later date. (See here.)


Thomas Pugh, UK Economist, +44 7568 378 042, thomas.pugh@capitaleconomics.com