The BOE kept rates unchanged at a record low 0.1% Thursday and promised it won’t tighten policy “until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.” Bond-buying will slow starting on August 11, and the bank still expects to complete the program (with a total stock of purchases of £745 billion), “around the turn of the year”.
This sounds dry, and it is, but the BOE’s situation encapsulates the dilemma facing monetary policymakers across the globe. Things seem to be improving on the economic front, policy has been pushed to extremes, but they’re essentially flying blind, and there are aggravating factors that make the situation even more indeterminate. In the UK’s case, that aggravating factor is Brexit.
So, what can you do? Well, you insert a placeholder meeting. The Fed has been in “placeholder” mode for months; the BoJ for years, with the exception of actions taken in and around the panic.
Of course, given the scope and severity of the current crisis, you can’t just tacitly preserve your optionality, you need to explicitly assert it. On QE, the BOE on Thursday said that with “liquidity conditions having stabilized, purchases can now be conducted at a slower pace than during the earlier period of market dysfunction”, but emphasized that “should market conditions worsen materially again… the Bank stands ready to increase the pace of purchases”. That’s a given. And the nod to optionality is, in a sense, perfunctory. But don’t underestimate the necessity of including it.
When it comes to negative rates, the bank summarized an internal review, which ultimately determined that the drawbacks outweigh the benefits. But later, Andrew Bailey told reporters that negative rates “are part of our toolbox” even as the bank doesn’t “plan to use them”. He reiterated that the BOE will do more if necessary.
On balance, the market initially viewed all of this as optimistic, if not “hawkish” per se. That view stems from the projections, and especially the inflation path.
“As a matter of fact, the inflation projections suggest that the MPC doesn’t expect having to add any new stimulus at all”, Rabobank said, in a lengthy review of the proceedings.
“Even though CPI inflation is projected to fall further this year — remaining firmly below the 2% target due to lower energy prices and the temporary VAT cut— the MPC’s central forecast is for inflation to then rise to around 2% in two years’ time… suggest[ing] the MPC already believes it will meet its remit without adjusting its current monetary policy stance”, Rabobank went on to say, adding that “it’s quite bold to actually forecast >2% inflation in little more than two years’ time, while at the same projecting that unemployment increases towards 7.5% at the end of the year”.
Bloomberg Economics tends to agree. “The Bank of England delivered a surprisingly upbeat message at its August meeting”, they marveled. “We still think it’s likely the central bank’s forecasts will prove too optimistic and more stimulus will be on the cards later in the year”.
On growth, the economy is seen recovering pre-pandemic levels by the start of 2022. You’re reminded that the COVID slump is generally seen as being the deepest economic downturn in three centuries.
When combined with March’s plunge, April’s contraction meant that two decades of UK growth disappeared in two months. The figure (below) is how things looked during the depths of the crisis.
One bank characterized the BOE’s projections for the economy as a “near-perfect scenario”, which is a polite euphemism for “never gonna happen”.
The MPC tacitly admits this is all just guesswork. “The evolution of the balance between demand and supply is hard to assess”, the statement reads. “The risks to the outlook for GDP are judged to be skewed to the downside”.
That’s probably a safe “judgement”. Although market participants initially focused on Bailey’s comment that the BOE doesn’t “plan” to use the negative rates that he said are, in fact, in the toolkit, you’d be forgiven for maintaining bets/calls for further easing, whether that’s an increase in the QE envelope by year-end or else a rate cut at some point. We’re already seeing signs of new restrictions in the UK aimed at ensuring the virus doesn’t make a comeback. The Brexit situation, meanwhile, is far from resolved.
“The UK economy faces a trifecta of risks”, Rabobank went on to say Thursday, citing the prospect of new COVID restrictions, Brexit, and labor market weakness. “We find it hard to see how this isn’t ultimately met with a monetary policy response”, they added.
Coming full circle, this is, in many ways, indicative of the dilemma facing policymakers in all advanced economies. They know damn well that forecasting is an exercise in abject futility and they also realize that the balance of risks is clearly skewed towards more easing, just as the economic balance is obviously skewed to the downside. But what are you gonna do, right? You throw out some numbers, and you try to stave off the inevitable as long as possible — in the BOE’s case, the inevitable is negative rates. Frankly, if you admit NIRP is in the toolbox, you’ve basically admitted you’re going to deploy it.
