The Bank of England is expected this week to hold back on providing further stimulus for the economy amid the coronavirus crisis, even as the central bank is also poised to downgrade its forecast for growth in gross domestic product in 2021.
Economists and financial market participants predicted the BoE Monetary Policy Committee would on Thursday look ahead to an economic recovery in the second half of this year, rather than focus on the current lockdown-induced downturn, allowing the MPC to say inflation is still on track to hit its 2 per cent target in the medium term.
And with medium-term forecasts for reasonable GDP growth by the BoE, most economists said the central bank was unlikely to implement negative interest rates this year.
In its quarterly report on Thursday, the MPC will provide an update on four crucial issues that determine its monetary policy stance. These are the current performance of the economy, the prospects for spending, the speed limits on GDP growth, and the likely effect of BoE monetary policy already implemented.
There is little doubt the MPC will downgrade the outlook for growth in the first quarter of 2021 following the surge in coronavirus cases since its last GDP forecast in November.
The BoE’s favourite measure of real-time spending comes from its own Chaps system, which monitors large payments made by credit and debt card companies on behalf of consumers to about 100 large UK retailers.
During the first three weeks of January, these payments were 35 per cent down on levels immediately before the Covid-19 pandemic, indicating the economy is likely to contract significantly in the first quarter after just edging higher in the last three months of 2020.
Although this would normally be a sign of weak demand that might require action from the BoE to boost spending, most economists think any move by the central bank would come too late to have a meaningful effect now. Moreover, there should be sufficient demand once the lockdown restrictions are lifted.
Paul Dales, economist at Capital Economics, said: “We suspect that any downward revisions to the GDP forecast [by the BoE] for the next six months will be offset by upward revisions for the following six months, to leave the MPC expecting GDP to return to its pre-crisis level in the first quarter of 2022.”
Some MPC members, such as BoE chief economist Andy Haldane, have predicted there will be a rebound in consumer spending to kickstart growth.
But it is not clear cut that the MPC as a whole will share this view because external members including Michael Saunders have warned that many households have weak finances and will prefer to save rather than spend during the recovery.
Shadow chancellor Anneliese Dodds pointed out last week that the government intended to cut universal credit, raise council tax bills and freeze public-sector pay, further weakening household finances this spring.
For the BoE, which is mandated to hit its 2 per cent inflation target set by the government, the MPC forecast for spending needs to be balanced against the potential for the economy to grow in the months ahead without unleashing big increases in the price of good and services.
So far, the MPC has judged that the Covid-19 crisis will ultimately leave scars worth 1.75 per cent of GDP, or about a half to a third of the expected damage wrought by Brexit.
Combined, these factors mean that once the economy has exited the current lockdown, it will probably start to generate inflation even at historically modest rates of GDP growth.
Some economists are therefore pessimistic about the economy’s ability to expand significantly in the post-coronavirus period.
Robert Wood, economist at Bank of America, said Brexit and a hangover from Covid-19, which includes “convincing” concerns about foreign workers leaving the UK, produced conditions of persistent weakness where “UK potential growth may be below 0.5 per cent a year”.
Many economists and financial market participants think a relatively large vaccine-induced bounce in the economy in the second half of this year means there should be little need for additional monetary stimulus in the months ahead.
The BoE’s flagship response to the pandemic has been an £895bn quantitative easing programme, under which it prints money to buy government bonds so as to provide monetary support for the economy.
Most economists think the BoE will not expand the stimulus, particularly given it is about to start purchasing £150bn of gilts as part of the £895bn programme.
The central bank has also promised an update on Thursday about its work looking at the case for negative interest rates, including whether banks’ systems would allow them to go to less than zero, but few economists think the MPC will implement the policy in the near future because of the prospects for growth in the medium term.
Cathal Kennedy, economist at RBC Capital Markets, said: “The negative rates ship may have sailed.”
Following the BoE’s own watchdog saying this month that the central bank had “knowledge gaps” on QE, economists said it needed to show it fully understood the impact of its programme as well as its guidance that rates would not rise until there was “clear evidence” of inflationary pressures.
Richard Barwell, head of macroeconomic research at BNP Paribas, said: “The public needs to know whether the central bank thinks it is at the lower bound for interest rates, what effect the BoE thinks the £895bn spent on QE has had, and whether guidance [on interest rates] works.”