Evidence of renewed momentum may stay MPC’s hand - Capital Economics
UK Economics

Evidence of renewed momentum may stay MPC’s hand

MPC Watch
Written by Ruth Gregory

January’s interest rate decision is shaping up to be one of the closest for some time. While the incoming economic news relating to the end of last year has made the case for an immediate cut, the resurgence in the timelier activity surveys has provided a reason for the Monetary Policy Committee (MPC) to stand pat. Our instinct is that the MPC will keep rates on hold at 0.75% on 30th January, but it will be close.

  • January’s decision whether to cut rates is very close
  • We think that the MPC will keep rates on hold as the economy appears to have turned a corner
  • We expect the next move in interest rates to be up rather than down, albeit not until 2021

January’s interest rate decision is shaping up to be one of the closest for some time. While the incoming economic news relating to the end of last year has made the case for an immediate cut, the resurgence in the timelier activity surveys has provided a reason for the Monetary Policy Committee (MPC) to stand pat. Our instinct is that the MPC will keep rates on hold at 0.75% on 30th January, but it will be close.

Strong case for immediate action

The main reason why the MPC shied away from a rate cut in December was because of its desire to see whether the election result had prompted a reduction in Brexit uncertainty and a turnaround in the data. Indeed, had it not been for the decisive election result, the MPC would probably have already lowered interest rates.

The question now is whether the news over the past month has alleviated the Committee’s concerns. If anything, the official data has weakened. Admittedly, the falls in GDP in November and in retail sales volumes and CPI inflation in December, are “old news” since the figures mostly relate to the period before the election. Even so, these developments will only have increased the perception amongst some MPC members that the deteriorating outlook warrants immediate action.

Indeed, in a recent speech, Michael Saunders argued that “if we defer easing in the near term…then risks of a low inflation trap – which would certainly not be a benign outcome – would rise”. Jonathan Haskel reiterated that he too “judges a lower rate…to be more appropriate”. (See Table 2 on page 3.) Both MPC members therefore look almost certain to vote for rates to be lowered, for the third consecutive meeting. And other members of the Committee, including Gertjan Vlieghe and Silvana Tenreyro have also sounded closer to voting for a rate cut in their recent public appearances.

But strong reasons not to cut

Of course, December’s policy statement and minutes showed that not everyone is convinced that rates need to be cut. And some MPC members might have taken heart from the recent signs that a burst of activity is in train. (See Chart 1.) The Committee will presumably have been comforted by the larger-than-expected rise in employment in November too, especially given that it is putting more weight on the labour market to help it determine how much slack there is in the economy.

Chart 1: Activity Surveys (Standardised)

Sources: Refinitiv, Capital Economics

This may have reduced the chances that those members of the MPC – who voted to keep rates on hold in December and were waiting to see how the data evolve – will switch sides.

Of course, the MPC may need more than a few surveys to persuade it that growth is going to pick up in the coming months. But at the very least, the rebound in the activity surveys might prompt the MPC to take a rain check until its next meeting on 26th March, by which time it will know whether GDP growth and inflation recovered in January, as well as the size of any fiscal stimulus announced in the Budget on 11th March. After all, while it has incorporated the 0.6% of GDP fiscal stimulus announced in the 2019 Spending Round into its forecasts, it has yet to include the additional fiscal stimulus worth 0.5% of GDP that we think will be set out in the Budget.

So there are sensible arguments either way. It may partly come down to the risks. On the one hand, if the MPC is going to cut rates then it might be better to do so sooner rather than later, since the cut could be reversed. Equally, with rates at 0.75%, the MPC might not want to use up ammunition unnecessarily.

One last hurrah for Carney?

Meanwhile, it is possible that Governor Carney’s imminent departure will sway January’s rate decision. It is not difficult to imagine Carney voting to cut rates in a move reminiscent of ECB President Mario Draghi’s decision last September to loosen policy only a few months before Christine Lagarde took over. And crucially, since 1997, the interest rate votes of the MPC insiders that work at the Bank every day have been the same as the Governor’s 83% of the time. Equally, though, Carney may be reluctant to rock the boat only a few months before Andrew Bailey takes the helm on 16th March.

Overall, there are powerful arguments both for and against a rate cut. Our instincts are that it is more likely that the MPC will keep rates on hold as arguments for a cut are overshadowed by signs that the economy has turned a corner. Indeed, while we expect the MPC to revise down its forecast for 2020 GDP growth from 1.25% to 1.00%, it may leave its 2021 growth projection of 1.8% unchanged and continue to predict that inflation reaches its 2% target by 2022. But the vote will be close and we expect a 5-4 split in favour of keeping rates on hold.

Timing of the next move

At the very least, the possibility of a rate cut is likely to linger for some months. Note that the markets think that if the MPC doesn’t cut rates in January, it will lower them at its next meeting on 26th March. Indeed, overnight interest rate swaps point to a 58% chance of a cut by March.

As for whether the MPC fulfils these expectations, if the economy remains weak in the early part of this year – suggesting that Q4’s likely dip was not entirely due to temporary factors – then we doubt the MPC will continue to stand by idly. But if the data continue to improve and a big fiscal stimulus is announced in the Budget on 11th March, then the odds of a cut are likely to recede.

We think that if rates are not cut in January, then at the following meetings the MPC will be able to conclude that the economy is strengthening and that lower rates are no longer needed. We suspect that if policy is changed in the next few years, it is more likely to be tightened than loosened, albeit not until 2021. We have pencilled in one 25bp rise from 0.75% to 1.00% in May 2021. (See Table 1.) This is a more hawkish profile than that priced into the financial markets and anticipated by the consensus. (See Chart 2.)

Chart 2: Expectations for Bank Rate (%)

Sources: Bloomberg, Capital Economics

Table 1: MPC Meeting Outcomes & Forecast

Date

Outcome/Forecast

Date

Outcome/Forecast

30th Jan. 2020*

0.75%

Feb. 2021*

0.75%

26th Mar. 2020

0.75%

Mar. 2021

0.75%

7th May 2020*

0.75%

May 2021*

1.00%

18th Jun. 2020

0.75%

Jun. 2021

1.00%

6th Aug. 2020*

0.75%

Aug. 2021*

1.00%

17th Sep. 2020

0.75%

Sep. 2021

1.00%

5th Nov. 2020*

0.75%

Nov. 2021*

1.00%

17th Dec. 2020

0.75%

Dec. 2021

1.00%

Sources: Bank of England, Capital Economics. *Denotes publication of Monetary Policy Report.

Table 2: Summary of MPC Members’ Views (Members ordered from most dovish to most hawkish)

Member

Term End

Previous Vote

Past Non-Consensus Votes

Recent Key Comments

Michael Saunders
(External Member)

Aug. 2022

Rates: 0.50%

Gilts: £435bn

Corp. bonds: £10bn

Voted to cut rates in Nov.

and Dec. 2019.

Voted to raise rates in Jun.-Sep. 2017 and Mar.-Jun. 2018.

“If we defer easing near term and, in the event of persistent economic weakness, face the need for greater easing later on, then risks of a low inflation trap – which would certainly not be a benign outcome – would rise.”(Speech in Northern Ireland, 15th Jan.)

Jonathan Haskel
(External member)

Sep. 2021

Rates: 0.50%

Gilts: £435bn

Corp. bonds: £10bn

Voted to cut rates in Nov.

and Dec. 2019.

“I now judge a lower rate and a more protracted period of looser monetary policy to be more appropriate.” (Speech in London, 20th Dec.)

Gertjan Vlieghe
(External member)

Sep. 2021

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

Voted to cut rates in Jul. 2016, while the other 8 members voted to keep rates on hold.

“I really need to see an imminent and significant improvement in the U.K. data to justify waiting [to cut rates] a little bit longer.” (Interview with Financial Times, 12th Jan.)

Silvana Tenreyro
(External member)

Jul. 2020

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

None.

“If uncertainty around the future trade arrangement or subdued global growth continued to weigh on U.K. demand then my inclination is to respond with a vote for a cut in rates in the near term.” (Speech in London, 10th Jan.)

Sir Jon Cunliffe
(Deputy Governor – Financial Stability)

Oct. 2023

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

Voted against raising rates in Nov. 2017.

“Pay growth [is] in the 2.5-3% range. But the latest readings do not signal strongly that pay growth will make the step to establish itself firmly in 3% territory… We may be underestimating supply in the labour market.” (Treasury Committee Questionnaire, 17th Oct 2018.)

Ben Broadbent
(Deputy Governor – Monetary Policy)

Jun. 2024

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

Voted against QE extension in Jul. 2012.

“Were the economy to develop in line with our projection . . . interest rates would probably have to rise by a little more than what was in the curve at the time of the May forecast.” (Treasury Committee, 12th Jun.)

Mark Carney
(Governor)

Jan. 2020

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

None.

“Much hinges on the speed with which domestic confidence returns. As is entirely appropriate, there is a debate at the MPC over the relative merits of near term stimulus to reinforce the expected recovery in U.K. growth and inflation.” (Speech in London, 9th Jan.)

Sir Dave Ramsden
(Deputy Governor – Markets & Banking)

Sep. 2022

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

Voted against raising rates in Nov. 2017.

“I also think spare capacity might not have opened up that much despite that weakness in underlying growth, because I think supply potential…is also slowing through this period. That comes through for me pretty clearly in the latest productivity numbers.” (Telegraph, 13th Oct.)

Andy Haldane
(Chief Economist)

Jun. 2020

Rates: 0.75%

Gilts: £435bn

Corp. bonds: £10bn

Voted to raise rates in Jun. 2018.

“…I would be cautious about loosening monetary policy, barring a sharp downturn in demand in the economy. Despite slowing, underlying UK growth remains only a little below potential and the labour market remains tight.” (Evidence to Treasury Committee, 4th Sep.)

Sources: Bank of England, Bloomberg.


Ruth Gregory, Senior UK Economist, +44 20 7811 3913, ruth.gregory@capitaleconomics.com