MPC’s words are much more dovish than its numbers - Capital Economics
UK Economics

MPC’s words are much more dovish than its numbers

UK Economics Update
Written by Ruth Gregory

The Monetary Policy Committee left its interest rate and quantitative easing policies unchanged today and its new projections appear to suggest that no further loosening is required. But its dovish language is more important for the future path of policy. That’s why we still think that the MPC will expand QE by £100bn in November and a further £150bn by the end of 2021.

  • The Monetary Policy Committee (MPC) left its interest rate and quantitative easing (QE) policies unchanged today and its new projections appear to suggest that no further loosening is required. But its dovish language is more important for the future path of policy. That’s why we still think that the MPC will expand QE by £100bn in November and a further £150bn by the end of 2021.
  • On the face of it, the MPC’s new economic projections do not point to any more stimulus. The size of the fall in GDP in the first half of 2020 has been lowered from 28% to 23%, and the medium-term path for GDP was largely unchanged. The Bank has lowered the peak in the unemployment rate from 9% in Q2 to 7½% by Q4 2020. It judges that there will be excess demand in the economy by Q3 2022. And it thinks that CPI inflation will rise above the 2% target in Q3 2022. Admittedly, these forecasts are based on market interest rate expectations for a further loosening in policy. But even if the Bank were to leave policy unchanged, inflation is still projected to be above 2% in 2023.
  • Meanwhile, the Bank thoroughly bashed the idea of negative interest rates, at least in the next six months or so. It suggested that while negative rates can work in some circumstances, it would be “less effective as a tool to stimulate the economy” at this time when banks are worried about future loan losses. And that it has “other instruments available”, including QE and forward guidance.
  • What’s more, by reiterating that the MPC still expects the £300bn of purchases announced between the March and June meetings to continue until the “turn of the year”, that implies that the pace of purchases will slow further to about £4bn a week, down from £14bn a week at the height of the crisis and £7bn more recently. So this all suggests that the Bank thinks that it has done enough. Its forecasts, if anything, point to the need to tighten policy!
  • However, there are two reasons why we think the Bank will end up loosening policy further. First, the signal from the forecasts contrast with the markedly dovish language in the Monetary Policy Report (MPR). The MPC acknowledged that the “medium-term projections were a less informative guide than usual”. And the minutes were littered with references to the downside risks, which are judged to persist both in the short- and medium term.
  • And the Bank introduced a new phrase in the policy statement, namely 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% target sustainably”. That seems designed to dilute the message from the forecasts and show that even when inflation rises to 2%, the MPC is not in any hurry to tighten policy. In that sense, the Bank is kind of suggesting that we should ignore its forecasts!
  • Second, the Bank’s GDP and inflation forecasts look a bit too optimistic to us. (See Chart 1.) Our view is that inflation will be closer to 1.5% by the end of 2022. (See Chart 2.) That’s why we believe that the Bank will still have to increase its policy support. We are sticking with our view that the MPC will expand QE by a further £250bn in total by the end of 2021, and that it will keep interest rates at +0.10% or below for at least five years. That’s much more dovish than other forecasters.

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

Chart 2: CPI Inflation (%)

Sources: Refinitiv, Bank of England, Capital Economics

Sources: Refinitiv, Bank of England, Capital Economics


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