Strength of initial rebound won’t prevent more QE - Capital Economics
UK Economics

Strength of initial rebound won’t prevent more QE

UK Economics Update
Written by Andrew Wishart

As the Bank of England already has a QE programme in place and financial markets have remained calm, it was no surprise that the MPC voted unanimously to keep policy unchanged in September. But we think that it will loosen policy further, most likely in the form of more QE rather than negative interest rates as the market expects. We’ve pencilled in an extra £250bn of QE over the course of the next year, with an instalment of £100bn in November. That’s more than the consensus expects.

  • As the Bank of England already has a QE programme in place and financial markets have remained calm, it was no surprise that the MPC voted unanimously to keep policy unchanged in September. But we think that it will loosen policy further, most likely in the form of more QE rather than negative interest rates as the market expects. We’ve pencilled in an extra £250bn of QE over the course of the next year, with an instalment of £100bn in November. That’s more than the consensus expects.
  • The recent activity data has been better than the MPC expected, leading it to drop the line that “the risks to the outlook for GDP are judged to be skewed to the downside.” Indeed, the Bank revised up its near-term GDP forecast, and its payments data suggest that consumer spending has already made a full recovery. So at face value, it doesn’t appear as though the MPC is gearing up to put in place more policy support.
  • However, the Committee didn’t put much weight on the strength of the recovery so far because “given the risks, it was unclear how informative [it is] about how the economy would perform further out.” Indeed, the Bank still thinks that GDP will be 7% below its pre-virus level in Q3. And the MPC is worried that a sharp rise in unemployment after the furlough scheme ends will prove “persistent” due to structural changes in the economy. That’s why in a recent speech Michael Saunders, the most dovish member of the committee, said he expects that the MPC will eventually have to undertake more monetary easing.
  • What’s more, the Bank said the resurgence in virus cases could “weigh further on economic activity”. And while it will wait until November to consider the economic issues related to Brexit (it currently assumes that a comprehensive trade deal is struck), it is clearly growing more concerned about it. It said the “nature of, and transition to” Brexit sat alongside the pandemic as a key determinant of growth and inflation.
  • We expect the economic recovery to become harder and slower, and inflation to languish at 1.5% rather than recover to 2.0% in 2022 as the Bank forecast in August. With the current QE programme set to be completed “around the turn of the year”, the next meeting on 5th November will be a good time to announce more stimulus.
  • The comment that “the MPC had been briefed on the Bank of England’s plans to explore how a negative Bank Rate could be implemented effectively” led the markets to assume that the chances of negative rates have increased. The pound and gilt yields fell. But the Bank will only start working out how to put negative rates into practice in Q4. And even then it will remain concerned about their effectiveness when banks are absorbing loan losses. So for the next 6-12 months at least we think that QE will remain the tool of choice.
  • At the moment the Bank’s QE programme is due to end before the Fed’s open-ended purchases and the ECB’s PEPP. (See Chart 1.) We expect the MPC to undertake a further £250bn of QE in total, which is much more than the consensus forecast of just another £75bn. (See Chart 2.) The next instalment, of £100bn, will probably be announced in November (consensus £50bn).
  • In any case, with the MPC today repeating the guidance that it won’t tighten policy “until there was clear evidence that significant progress was being made in eliminating spare capacity and achieving the 2% inflation target”, we expect interest rates to be 0.10% or less for the next five years.

Chart 1: Stock of QE Purchases (Jan. 2020 = 100)

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

Sources: Refinitiv, Bank of England, Capital Economics

Sources: Bank of England, Bloomberg, Capital Economics


Andrew Wishart, UK Economist, +44 (0)7427 682 411, andrew.wishart@capitaleconomics.com