MPC still warning about a cut, but it may not deliver - Capital Economics
UK Economics

MPC still warning about a cut, but it may not deliver

UK Economics Update
Written by Ruth Gregory

The MPC kept interest rates on hold at 0.75% today but left the door open to a rate cut in the coming months. Nonetheless, with the economy turning a corner and a big fiscal stimulus approaching, we suspect the next move in interest rates will be up not down – albeit not until next year.

  • The MPC kept interest rates on hold at 0.75% today but left the door open to a rate cut in the coming months. Nonetheless, with the economy turning a corner and a big fiscal stimulus approaching, we suspect the next move in interest rates will be up not down – albeit not until next year.
  • The MPC remained on hold as we had expected (note that only a few weeks ago the financial markets were pricing in a 70% chance of a cut). And contrary to expectations of a 6-3 split, only Michael Saunders and Jonathan Haskel once again voted to loosen policy. But the seven members who voted to leave rates on hold in January appeared to want to wait longer to see how things pan out.
  • The MPC’s forecasts in the January Monetary Policy Report imply that a further loosening may be required. This year’s GDP growth forecast has been reduced from 1.2% to 0.8% and the Bank cut its 2021 forecast too, from 1.8% to 1.4%. (See Chart 1.) What’s more, on the basis of the market path for interest rates, the MPC expects inflation to only just reach the 2% target in two years’ time. Accordingly, the MPC seems to have endorsed market expectations that interest rates need to fall to 0.50% and stay there.
  • The policy statement struck a dovish tone too. The MPC kept (but tweaked) its “up/down” guidance that states “should the positive signals from the indicators of global and domestic activity not be sustained” then the MPC will cut rates, and if neither of those things happen and the economy recovers, then the MPC will “modestly” raise rates. But for the first time it said that it now also needs to see a pick-up in domestic price inflation to prevent it from cutting rates. And it now thinks any future tightening will be “modest” rather than “gradual and limited” – Bank speak for there being only one rather than multiple rate rises.
  • Governor Carney sounded a note of caution in his last press conference before Andrew Bailey takes the helm too. He said that “these are still early days, and it is less of so far so good, than, so far, good enough” and “it will be important for the hard data on activity to follow through on the recent pickup in the surveys”.
  • Admittedly, there were some hawkish elements. The Bank of England still thinks there will be some excess demand in the economy by 2021, albeit a little less than in November (0.25% of GDP rather than 0.50%). And it continues to think inflation will breach its 2% target by 2022, which explains why the Committee retained its guidance that rates may need to rise eventually.
  • For our part, we think the incoming hard data will live up to expectations and that the Budget on 11th March will deliver a fiscal stimulus which will boost growth and inflation. Indeed, the Bank of England has yet to include the additional fiscal stimulus worth 0.5% of GDP that we think will be set out in the Budget.
  • Overall, there’s clearly a decent chance of a rate cut in either March or May. But our best bet is still that a strengthening in the economy and a big fiscal stimulus will mean that rates will remain on hold at 0.75% this year, before rising to 1.00% by the end of 2021, a good deal above current market expectations. (See Chart 2.)

Chart 1: GDP (% y/y)

Chart 2: Expectations for Bank Rate (%)

Sources: Bank of England, Capital Economics

Sources: Refinitiv, Bloomberg, Capital Economics


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