Extra £150bn of QE unlikely to be the last expansion

  • Back in June, we predicted that the Bank of England would expand quantitative easing (QE) by a further £350bn over the following 18 months (consensus £100bn). (See here.) By announcing an extra £150bn of QE today, the Bank has already done £250bn of that. That leaves £100bn to come. And if anything, in 2021 it’s possible that the Bank will increase QE by even more than that.
  • Not only was the vote to increase QE unanimous, but the £150bn expansion was slightly bigger than the £100bn that we had expected. The MPC noted that “announcing further asset purchases now should support the economy and help to ensure the unavoidable near-term slowdown in activity was not amplified by a tightening in monetary conditions that could slow the return of inflation to the target”.
  • Meanwhile, in the accompanying Monetary Policy Report, the Bank revised down its Q3 GDP growth forecast from +18.3% q/q to +16.2% q/q and from +3.5% q/q to -2.0% q/q in Q4. At the same time, it raised the peak in the unemployment rate from 7½% in Q4 2020 to 7¾% in Q2 2021. Admittedly, the MPC’s new projections do not necessarily point to any further stimulus. CPI inflation is still projected to be a bit above its 2% target by the start of 2023 and the “inflation risks were judged to be balanced”. The Bank also expects there to be excess demand in the economy by Q4 2022. What’s more, the MPC does not expect to complete the £150bn of new asset purchases until around the end of 2021. And it has historically tended to wait until the current round is almost finished before announcing more QE. This suggests that the Bank thinks it has done enough for now.
  • Even so, the minutes were littered with references to the downside risks. The MPC reiterated that the “recovery would take time, and the risks around the GDP projection were judged to be skewed to the downside”. It also said “the risk of a more persistent period of elevated unemployment remained material”.
  • What’s more, the Bank’s GDP and inflation forecasts still look way too optimistic to us. Rather than reaching its pre-pandemic level in Q1 2022, our view is that it will take until 2023 for the economy to return to its pre-pandemic level. (See Chart 1.) And we think that inflation will be closer to 1.5% by the end of 2022. (See Chart 2.) That’s why we believe the Bank will still have to increase its policy support in 2021.
  • As to what form further policy support might take, there was no mention of negative interest rates (NIR) in the minutes or Monetary Policy Report, suggesting the MPC still remains some way from being persuaded of the case for such a policy. However, we wouldn’t rule out NIR being used further down the line. After all, rather than saying that it “stands ready to adjust monetary policy”, the MPC today suggested that it will take “whatever additional action was necessary to achieve its remit”. The latter seems stronger and wider and may indicate the Bank’s willingness to embrace new tools.
  • Overall, we are sticking with our view that the MPC will shun NIR for the next 6-12 months and instead expand QE by at least another £100bn in 2021, far more than the consensus expects. Meanwhile, with the MPC 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” we expect interest rates to be no higher than +0.10% for the next five years. That is likely to keep 10-year gilt yields close to 0.15% for the next few years. Today, they have already fallen back towards that forecast.

Chart 1: Level of Real GDP (Q4 2019 = 100)

Chart 2: CPI Inflation (%)

Sources: BoE, Capital Economics

Sources: BoE, Capital Economics

Ruth Gregory, Senior UK Economist, +44 (0)7747 466 451, ruth.gregory@capitaleconomics.com

Ruth Gregory Senior UK Economist
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