MPC to expand QE in response to second wave of the virus - Capital Economics
UK Economics

MPC to expand QE in response to second wave of the virus

MPC Watch
Written by Ruth Gregory

Back in June, we were pretty much alone in forecasting that the MPC would expand quantitative easing (QE) by £100bn at its meeting on 5th November. That call looks on track, and most other forecasters have now come round to our view. But we think that the consensus is still underestimating how much more QE the MPC will announce in 2021. We expect the Bank to expand QE by a further £150bn by the end of 2021.

  • Consensus comes round to our view that MPC will expand QE by £100bn in November
  • This won’t be the last QE expansion
  • Negative rates are possible, but probably not for another 6-12 months

Back in June, we were pretty much alone in forecasting that the MPC would expand quantitative easing (QE) by £100bn at its meeting on 5th November. (See here.) That call looks on track, and most other forecasters have now come round to our view. But we think that the consensus is still underestimating how much more QE the MPC will announce in 2021. We expect the Bank to expand QE by a further £150bn by the end of 2021.

Downside risks materialize

While the Bank of England kept interest rates at +0.10% at the last policy meeting in September and maintained its previous £300bn expansion in QE, it continued to highlight the downside risks to its economic projections. Since then, those downside risks have materialized in four main ways.

First, GDP in Q3 has been weaker than the Bank anticipated. That will prompt the Bank to reduce its Q3 GDP growth forecast from +18.3% q/q at the time of the August Monetary Policy Report, perhaps to +15% or +16%. Admittedly, the unemployment rate only rose to 4.5% in August, rather than to 4.8% as the Bank expected. And CPI inflation has not fallen as far as it thought. Even so, the weaker starting point for GDP is likely to bear down on inflation further ahead.

Second, in August the Bank based its projections on the assumption that the direct impact of COVID-19 on the economy would “dissipate gradually over the forecast period”. But the second wave of the virus and the direct effect of the re-imposition of containment measures will prompt the Bank to, at the very least, revise down its Q4 GDP growth forecast from 3.5% q/q.

Third, the indirect effect of households and firms becoming more reticent to spend due to the second wave of the virus may also keep GDP and inflation lower for longer and unemployment higher.

Fourth, if there is a Brexit deal, it looks like it will be a looser arrangement than the Bank assumed. In August, its projections were based on an “orderly move to a comprehensive free trade agreement with the EU on 1st January 2021”. The Bank may now assume that a slim trade deal is agreed instead, which would put further downward pressure on its GDP forecasts. However, this might come in the form of a permanent reduction in the economy’s supply potential, which would not necessarily put downward pressure on the Bank’s inflation forecasts.

The Bank might publish a “sensitivity analysis” in the accompanying Monetary Policy Report illustrating how its forecasts would change if there were a comprehensive deal or a no deal Brexit. But given the Bank’s reluctance to forecast the effects of a no deal in the past, the latter seems unlikely.

All this may mean that instead of forecasting that the economy returns to its pre-crisis level at the end of 2021, the Bank may assume that it may not get there until the second half of 2022. The unemployment rate may peak at closer to 8% than the 7.5% level it assumed in August. And we expect the Bank’s new inflation forecasts (based on constant +0.10% rates and £300bn of QE) to show that inflation is expected to undershoot the 2% target at the end of the forecast period. That would suggest the £300bn of QE announced since March is not sufficient to raise inflation back to its 2% target by 2023.

So most MPC members will probably decide that more policy support is necessary. Indeed, on 18th October, Bank Governor Andrew Bailey said that the “risks remain very heavily skewed towards the downside”. And Gertjan Vlieghe suggested that “the risks are…skewed towards additional monetary stimulus”.

Admittedly, not all members seem convinced. In a speech last month, Andy Haldane sounded sanguine arguing that “the good news on the economy is being crowded-out by fears about the future”. Given the resurgence in the virus, his view may have changed since then. Even if it hasn’t, he may be on his own.

Of course, it is questionable what the Bank can actually do to support the economy in the near term. It cannot hope to prevent a renewed downturn resulting from a ramping up in the COVID-19 restrictions. But further monetary stimulus can help to keep firms afloat and limit job losses, thereby allowing the economy to be in a better place once the virus has been brought under control.

Agreeing on action, but divided on how to do it

The key question is what form the further policy stimulus will take. The MPC seems divided on negative interest rates (NIR). Some external MPC members seem open to the idea of using NIR straight away. Vlieghe said in a recent speech “the risk that negative rates end up being counterproductive to the aims of monetary policy is low”. Silvana Tenreyro has suggested that the evidence from overseas of the effectiveness of NIR has been encouraging. But the “insiders” on the MPC have made it clear that negative rates aren’t imminent. In a speech last week, Dave Ramsden suggested that “while there might be an appropriate time to use negative interest rates, that time is not right now”.

These divisions on the Committee are not too surprising given that in the current circumstances, none of the MPC’s tools are perfect for the job. (See Table 1.) QE is most effective in times of financial stress when, as Governor Andrew Bailey put it, it pays to go “big and fast”. But with market functioning restored, the Bank doesn’t need to increase QE by £200bn like it did in March and it doesn’t need to go as fast either. It has already slowed the pace of its weekly purchases from about £14bn a week to £2bn a week. (See Chart 1.)

Chart 1: BoE Asset Purchases Per Week (£bn)

Source: BoE

Similarly, the Bank’s lending facilities are useful at times of financial stress and when there is a tightening in credit conditions. So at present, there is no pressing need to alter the Covid Corporate Financing Facility (CCFF) or the Bank’s Term Funding Scheme with additional incentives for Small and Medium-sized Enterprises (TFSME).

After all, there is still plenty of room within these schemes. The Bank has lent £15bn to businesses so far via the CCFF, but there is no cap. And while banks can borrow up to 10% of their outstanding loans, equating to £200bn or 9% of GDP using the TFSME, they have so far only borrowed £46bn (2% of GDP). That said, we would not rule out the Bank tweaking the TFSME to make it more appealing.

Table 1: Monetary Policy Toolkit

Timeline

Policy Stimulus

Most Effective

March

“Big and fast” QE

Times of financial stress.

March

Lending facilities CCFF, TFSME

Financial stress. Tightening in credit conditions.

Late-2020 to end-2021?

Steady QE

Early stage of the recovery.

Late-2021 onwards?

Negative Interest Rates

A more mature stage of the recovery.

Source: Capital Economics

Finally, NIR are more effective during the early stages of an economic upturn than they are during an economic downturn. That’s because during a downturn, banks are concerned about future loan losses and are more likely to respond to any squeeze on their profitability by reducing the supply of credit. So they may not be very effective now. (See here.)

What will it do?

For the time being, we suspect that the MPC will use smaller, slower QE as its primary tool. (See Table 2.) Indeed, in a recent speech, Ramsden suggested that “for delivering a defined dose of economic stimulus, a large, steady programme of gilt purchases may be most appropriate”.

Admittedly, the £300bn of asset purchases voted for between March and June have not been completed yet. At the current pace of purchases of £2bn a week, it will take another three months to complete. And the MPC has historically tended to wait until the current round is almost finished before announcing more QE. So it’s possible that the MPC will park the decision on more QE until its subsequent policy meeting on 17th December. But with the economic outlook rapidly deteriorating, we suspect the MPC will want to act next week.

As a result, we think the MPC will probably announce another £100bn of QE at its November meeting. And we suspect that the vote will be a conclusive 8-1, with only Haldane voting to keep policy unchanged, as he did in June. (See Table 3.) Assuming that these purchases are spread out evenly over the first five months of the year, that would represent a similar rate of purchases to the £4bn per week seen in September and would take the MPC up to its May 2021 meeting.

This extra QE will probably come in the form of more gilt purchases. After all, with corporate bond spreads continuing to narrow, more corporate bond purchases don’t seem necessary. (See here.)

Regardless of what the MPC announces next week, we doubt it will be the last bout of stimulus. The Bank will probably repeat the forward guidance added in August 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% [inflation] target sustainably”. It may even go further and say it will loosen policy more if it needs to. We expect the weak economy and low inflation to prompt the Bank to unveil £150bn more QE in 2021 compared with the consensus, which is following its usual pattern in thinking that the upcoming bout will be the last. (See Chart 2.) We wouldn’t rule out negative interest rates being used a bit further down the line. But for the next 6-12 months at least, we suspect the Bank will shun NIR.

Chart 2: Forecasts for the Stock of QE Purchases (£bn)

Sources: Capital Economics, Refinitiv

Overall, anything the MPC does now will do little to prevent a renewed recession if virus cases continue to rise and the government ramps up the COVID-19 restrictions. So monetary policy can’t solve all economic ills and it is far less well targeted than fiscal support. Even so, monetary policy is set to remain very loose for a very long time. That is likely to keep 10-year gilt yields close to 0.15% for the next few years, affording the government the fiscal space it needs to deal with the crisis.

Table 2: MPC Meeting Outcomes & Forecast

Date

Rates

QE

Date

Rates

QE

30th Jan. 2020*

0.75%

4th Feb. 2021*

0.10%

11th Mar. 2020 (Emergency meeting)

0.25%

18th Mar. 2021

0.10%

19th Mar. 2020 (Emergency meeting)

0.10%

+£200bn

6th May 2021*

0.10%

+£100bn

26th Mar. 2020

0.10%

24th Jun. 2021

0.10%

7th May 2020*

0.10%

5th Aug. 2021*

0.10%

18th Jun. 2020

0.10%

+£100bn

23rd Sep. 2021

0.10%

6th Aug. 2020*

0.10%

4th Nov. 2021*

0.10%

+£50bn

17th Sep. 2020

0.10%

16th Dec. 2021

0.10%

5th Nov. 2020*

0.10%

+£100bn

17th Dec. 2020

0.10%

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

Table 3: 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: 0.10%

QE: £745bn

Voted to increase QE by £100bn in May.

Voted to cut rates in Nov. & Dec. 2019 and Jan. 2020.

“Risk management considerations imply we should lean strongly against downside risks at present…I consider it quite likely that additional monetary easing will be appropriate in order to achieve a sustained return of inflation to the 2% target.” (Speech, 4th Sep.)

Jonathan Haskel
(External member)

Sep. 2021

Rates: 0.10%

QE: £745bn

Voted to increase QE by £100bn in May.

Voted to cut rates in Nov. & Dec. 2019 and Jan. 2020

“I stand ready to vote for more stimulus measures should they be needed.” (Speech, 5th Oct.)

Gertjan Vlieghe
(External member)

Sep. 2021

Rates: 0.10%

QE: £745bn

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

“The risks to the economic outlook are skewed toward a longer period of labour market slack with weak inflationary pressure…The risks to the monetary policy stance are therefore skewed toward additional monetary stimulus”. (Speech, 20th Oct.)

Silvana Tenreyro
(External member)

Jul. 2023

Rates: 0.10%

QE: £745bn

None.

“We have been discussing our toolkit in recent months, including how effective negative rates might be in the current context. The evidence has been encouraging.” (Interview with the Telegraph 27th Sep.)

Sir Jon Cunliffe
(Deputy Governor – Financial Stability)

Oct. 2023

Rates: 0.10%

QE: £745bn

Voted against raising rates in Nov. 2017.

“Given the economic hit – a very deep synchronised hit to the global economy – we can expect very significant losses on credit to firms and households.” (Webinar, 9th Jun.)

Andrew Bailey
(Governor)

Mar. 2028

Rates: 0.10%

QE: £745bn

None.

“Obviously there are different views, there are different views on the MPC on this, but my view, and the MPC have said publicly that the recovery will take time. The hard yards are still ahead”. (Testimony to the House of Lords Economics Affairs Committee in London, 13th Oct.)

Ben Broadbent
(Deputy Governor – Monetary Policy)

Jun. 2024

Rates: 0.10%

QE: £745bn

Voted against QE extension in Jul. 2012.

“Were there a serious concern that inflation would drift away from target, whether because of higher levels of debt or for any other reason, you’d expect to see it reflected in higher “breakeven rates” in gilts markets. Thus far that has not happened.” (Speech, 2nd Sep.)

Sir Dave Ramsden
(Deputy Governor – Markets & Banking)

Sep. 2022

Rates: 0.10%

QE: £745bn

Voted against raising rates in Nov. 2017.

“We have considerable headroom after the current [QE] program is completed.” (Speech, 21st Oct.)

Andy Haldane
(Chief Economist)

Jun. 2023

Rates: 0.10%

QE: £745bn

Voted against QE extension in Jun. 2020.

Voted to raise rates in Jun. 2018.

“We at the bank are doing work to ensure that that tool is in the toolbox. That is not remotely the same as saying that we are about to deploy that tool. That will depend on the balance of costs and benefits”. (Speech, 22nd Oct.)

Sources: Bank of England, Bloomberg, City AM, HoC Treasury Committee


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