Getting close to rate cuts, but the MPC to sit tight for now - Capital Economics
UK Economics

Getting close to rate cuts, but the MPC to sit tight for now

MPC Watch
Written by Ruth Gregory

If the Monetary Policy Committee (MPC) wanted to cut interest rates from 0.75% to 0.50% on Thursday 19th December, the continued weakness of both activity and underlying price pressures means it wouldn’t find it hard to justify doing so. However, we think there are enough reasons for the Committee to sit tight in December. Unless the tone of the economic news improves, though, rates could be cut early next year despite a Brexit deal.

  • Vlieghe might join Saunders and Haskel in voting for a cut
  • But the election result and prospect of a Brexit deal may mean the majority is content to wait
  • Chances of a rate cut arguably higher in January

If the Monetary Policy Committee (MPC) wanted to cut interest rates from 0.75% to 0.50% on Thursday 19th December, the continued weakness of both activity and underlying price pressures means it wouldn’t find it hard to justify doing so. However, we think there are enough reasons for the Committee to sit tight in December. Unless the tone of the economic news improves, though, rates could be cut early next year despite a Brexit deal.

While the MPC left interest rates unchanged at 0.75% at its 7th November meeting, the Committee struck a dovish tone saying that “if global growth fails to stabilise or if Brexit uncertainties remain entrenched, monetary policy may need to reinforce the expected recovery in UK GDP growth and inflation”. And for the first time since just after the EU referendum, some MPC members – Michael Saunders and Jonathan Haskel – voted to cut rates.

Ingredients for an interest rate cut are in place

Meanwhile, the data since the November meeting have generally supported the MPC’s dovish stance. Admittedly, the global economic backdrop has begun to improve a little. But the UK data has remained fundamentally weak. (See Table 1.) CPI inflation continued to trend lower, falling from 1.7% in September to 1.5% in October, its lowest level in almost three years. And October’s stagnation in GDP will have done little to alleviate the MPC’s concerns about a further weakening in the underlying pace of growth. Meanwhile, the all-sector PMI has fallen to levels often associated in the past with rate cuts.

What’s more, the two MPC members who voted to cut rates in November did so in part because of the weakening in the labour market. And since then, the labour market has deteriorated further.

So if the MPC wanted to cut interest rates from 0.75% to 0.50%, it wouldn’t find it difficult to justify. Indeed, it would be no surprise if the December minutes reveal that Michael Saunders and Jonathan Haskel voted for a rate cut again. And the latest data may have been sufficiently weak for a least one more dovish MPC member – possibly Gertjan Vlieghe – to join them.

Table 1: Data Background

Sources: Bank of England, Refinitiv, Capital Economics

But MPC may proceed cautiously

But we would hesitate to conclude that a majority of MPC members will vote for a rate cut on 19th December, for a few reasons.

First, the large majority secured by the Conservatives in the election might provide the MPC with more confidence to wait for the economic data to turn. After all, the clear result means that one of the MPC’s downside risks to activity, namely that Brexit uncertainty “remains entrenched”, has faded at least a bit. Of course, Johnson’s manifesto pledge not to extend the transition period beyond 2020 means that some uncertainty will linger. But the MPC may take comfort in the hope that the result puts the economy on a clearer path, allowing Johnson to pass his Brexit deal before 31st January and perhaps providing him with more political latitude to strike a trade deal with the EU and extend the transition period. (See here.)

This, together with the fact that the economy looks set to benefit from a fiscal stimulus of up to £20bn (or 1% of GDP) possibly in a Budget in February, should prompt GDP growth to regain some pace in 2021. Indeed, both we and the Bank forecast GDP growth to rise from about 1% in 2020 to 1¾% in 2021, above the 1¼% to 1½% that represents overheating according to the MPC.

This might also convince the MPC that inflation will return to the 2% target over its two-year policy horizon without the need for lower rates. After all, a stronger economic backdrop may mean that businesses are more confident that consumers will accept higher prices and pass on the recent rise in their costs. (See here.) In any case, the MPC might be cautious about taking the financial markets by surprise by cutting rates in December. Note that the markets are currently pricing in only a 2% chance of a 25bp rate cut.

Against this backdrop, our best bet is that the vote will be split 6-3 in favour of keeping rates on hold at 0.75% at the MPC’s meeting next Thursday. But the MPC may use the minutes to send a signal it would lower interest rates in the next month or two if the incoming economic data fails to recover.

Looking further ahead

Indeed, we suspect that unless the tone of the economic news improves, there’s a chance of rates being cut early next year even if there’s a Brexit deal.

It is not so much the GDP figures, but the labour market data released in the coming months that could tip the balance towards a rate cut. After all, at a time when the MPC is unsure whether the recent weakening in GDP growth is mostly due to cyclical issues or structural factors related to Brexit, which might not put downward pressure on inflation, the Committee is placing more emphasis on the labour market to judge this. (See here.)

However, regardless of whether or not interest rates fall to 0.50% in the coming months, one thing we can be certain of is that any tightening of monetary policy remains a long way off. (See Table 2.) In fact, we think it is highly unlikely that the MPC will raise interest rates at all in 2020 and probably for the best part of 2021 as well.

Table 2: MPC Meeting Outcomes & Forecast (Brexit Deal Scenario1)

Date

Outcome/Forecast

Date

Outcome/Forecast

19th Dec. 2019

0.75%

Feb. 2021*

0.75%

30th Jan. 2020*

0.75%

Mar. 2021

0.75%

26th Mar. 2020

0.75%

May 2021*

1.00%

7th May 2020*

0.75%

Jun. 2021

1.00%

18th Jun. 2020

0.75%

Aug. 2021*

1.00%

6th Aug. 2020*

0.75%

Sep. 2021

1.00%

17th Sep. 2020

0.75%

Nov. 2021*

1.00%

5th Nov. 2020*

0.75%

Dec. 2021

1.00%

17th Dec. 2020

0.75%

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

1For more details, see our UK Economic Update “Election eases Brexit handbrake but doesn’t release it”, 13th December 2019.

Table 3: Summary of MPC Members’ Views (Members ordered from most dovish to most hawkish)

Sources: Bank of England, UK Parliament, The Telegraph, Bloomberg.


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