The MPC tanker is turning - Capital Economics
UK Economics

The MPC tanker is turning

UK Economics Weekly
Written by Andrew Wishart

In recent years the economy has been moving towards full capacity, but at this week’s meeting the Monetary Policy Committee (MPC) judged that it has changed direction and slack is now opening up. Whether that continues, and whether the Committee contemplates interest rate cuts in response, depends on (you guessed it) Brexit.

In recent years the economy has been moving towards full capacity, but at this week’s meeting the Monetary Policy Committee (MPC) judged that it has changed direction and slack is now opening up. Whether that continues, and whether the Committee contemplates interest rate cuts in response, depends on (you guessed it) Brexit.

The dovish shift in tone at the September MPC meeting was partly due to new intelligence from the Bank’s network of Agents. With underlying growth now only “slightly positive” and Agents suggesting capacity utilisation had fallen the MPC judged that “a degree of slack [has] opened up in the economy”. (See Chart 1.) And while the MPC said it was “too early to judge that the labour market was loosening”, it added “it did not appear to be tightening further”.

Chart 1: Slack in the Economy

Sources: Refinitiv, BoE, Capital Economics

The judgement that slack is opening up is hardly a surprise as the MPC has been moving in that direction over the summer. The tanker started to turn in May when GDP growth was judged to be “marginally” below potential and the MPC went further in June when said it was “a little” below potential. It is striking that the MPC emphasised that slack is now emerging. That would appear to reduce the need for interest rate hikes and could bring rate cuts onto the agenda.

Whether or not the Bank follows other central banks and moves towards rate cuts depends on Brexit. The Government is denying it, but now Parliament has passed a law forcing it to ask for another extension to Article 50, Brexit will probably be delayed at least to the end of January.

For the first time, in addition to its previous comments about policy if there is a deal (“increases in interest rates, at a gradual pace and to a limited extent”) or a no deal (“monetary policy response would not be automatic, and could be in either direction”) the MPC said what it thought would happen if Brexit is delayed again. It suspects “demand growth would remain below potential” and “domestically generated inflationary pressures would be reduced”.

That conflicts with our view that GDP growth would accelerate a bit, which is based on the idea that each delay is less disruptive than the last one as the threat of no deal diminishes. The Bank’s view appears to be based on no deal remaining a strong possibility after each delay. If it is the latter, it makes sense to forecast continued weak growth and no change in interest rates, or perhaps even cuts depending on how the global economy performs.

As for what is likely, the pound has risen over the past month as news reports have suggested there has been some progress towards a deal. But there are still two big hurdles. First, it is far from certain that the Prime Minister will strike a deal. And second, if he does, it is not clear he could get it through Parliament. Keeping the DUP onside will be difficult if a Northern Ireland-only backstop is part of the solution. And even if the PM manages that, he would still have a “majority” of -41, and therefore need 21 MPs to switch sides, to get it through. Labour MPs in “leave” areas and Tory MPs who lost the whip voting against no deal could get the Government over the line but it will be very close!

Week ahead

The Supreme Court could rule that the prorogation of Parliament was illegal early next week, which might see MPs recalled. And the change to how student loans are counted implemented in the Public Finance data released Tuesday will raise borrowing.

Data Previews

Public Finances (Aug.) Tue. 24th Sep.

Forecasts

Time (BST)

Previous

Consensus

Capital Economics

PSNB ex. Banking Groups

09.30

-£1.3bn

£7.2bn

£7.2bn

New student loans treatment will make the deficit much bigger

The main event in August’s public finances data will be the ONS treating a portion of student loans as spending rather than lending for the first time, which will push up government borrowing.

The rationale is that as much student debt is never repaid and instead is eventually written off, it makes sense to treat some of it as spending grants instead of as loans. The portion of student loans treated like this will be based on expected future repayments. The ONS expects this will cause borrowing in 2018/19 to be revised up by about £12bn (0.6ppts of GDP). For more detail, see our Update.

The change probably won’t have made a difference to borrowing on the PSNB ex. measure in August. We can’t be certain, but we suspect the change will push up borrowing every September, January, and April, when students receive their loan instalments.

So far this year, modest growth in total receipts has been outstripped by much higher departmental spending, perhaps reflecting preparations for Brexit. If that trend had continued, borrowing in August would have been around £7.2bn, £1.3bn higher than a year earlier.

That would leave borrowing in the year to date almost 50% above the OBR’s forecast. Take that as a starting point, add the 2019 Spending Round giveaways and the change in student loan accounting, and it becomes clear that the Chancellor is likely to miss his fiscal target. (See Chart 2.)

Chart 2: Cyclically-Adj. Borrowing in 2020/21 (£bn)

Sources: OBR, ONS, Capital Economics, HM Treasury

Economic Diary & Forecasts

Upcoming Events & Data Releases

Date

Country

Release/Indicator/Event

Time (BST)

Previous*

Consensus*

CE Forecasts*

UK Data Response

Mon 23rd

No Significant Data Released

Tue 24th

UK

PSNB ex. Banking Groups (Aug)

(09.30)

-£1.3bn

£7.2bn

£7.2bn

DR

Tue 24th

UK

CBI Industrial Trends, Total Orders (Sep)

(11.00)

-13

-13

-13

Wed 25th

UK

CBI Distributive Trade Survey (Sep)

(11.00)

-49

-20

-30

Thu 26th

No Significant Data Released

Fri 27th

UK

GfK Consumer Confidence (Sep)

(00.01)

-14

-14

-12

DR

UK

BoE’s Michael Saunders speaks in Yorkshire

(08.00)

UK

UK Economic Sentiment Indicator (Sep)

(10.00)

92.5

Also expected during this period:

21st–25th

UK

Labour Party Conference

23rd–25th

UK

Supreme Court ruling on prorogation

Selected future data releases and events

Mon 30th

UK

GDP (Q2, Final)

(09.30)

DR

UK

Current Account (Q2)

(09.30)

DR

Tue 1st

UK

IHS Markit/CIPS Manufacturing PMI (Sep)

(09.30)

DR

UK

IHS Markit/CIPS Construction PMI (Sep)

(09.30)

Thu 3rd

UK

IHS Markit/CIPS Services PMI (Sep)

(09.30)

DR

Also expected during this period:

28th–3rd

UK

Nationwide House Prices (Sep)

29th–2nd

UK

Conservative Party conference

*m/m(y/y) unless otherwise stated

Sources: Bloomberg, Capital Economics

Main Economic & Market Forecasts**

%q/q(%y/y) unless stated

Latest

Q1 2019

Q2 2019

Q3 2019

Q4 2019

2019

2020

2021

GDP

-0.2(+1.2)

+0.5(+1.8)

-0.2(+1.2)

+0.4(+1.0)

+0.2(+1.0)

(+1.3)

(+1.5)

(+2.0)

Household spending

+0.5(+1.8)

+0.6(+1.9)

+0.5(+1.8)

+0.5(+1.9)

+0.5(+2.1)

(+1.9)

(+2.0)

(+1.8)

CPI inflation (%)

(+1.7) (Aug)

(+1.9)

(+2.0)

(+1.9)

(+1.8)

(+1.9)

(+2.1)

(+2.3)

ILO unemployment rate (%)

3.8 (Jul)

3.8

3.9

3.9

3.9

4.0

4.0

4.0

Bank rate, end period (%)

0.75

0.75

0.75

0.75

0.75

0.75

1.00

1.25

10 yr gilt, end period (%)

0.63

1.00

0.83

0.80

1.00

1.00

1.25

1.75

$/£, end period

1.25

1.32

1.27

1.23

1.25

1.25

1.30

1.35

Euro/£, end period

1.13

1.17

1.12

1.11

1.19

1.19

1.13

1.17

Sources: Capital Economics, Refinitiv

** Based on a scenario in which Brexit is repeatedly delayed. For more see our UK Economics UpdatePick your own Brexit forecast”, 1st July 2019.


Andrew Wishart, UK Economist, +44 20 7808 4062, andrew.wishart@capitaleconomics.com