In a rare demonstration of togetherness, the Bank of England MPC meeting of 17 March 2021 saw a unanimous vote favouring maintaining the current monetary policy. This steady as she goes approach to monetary policy comes ahead of the May MPC meeting, which will see a raft of new economic forecasts considered. Currently, the MPC appears more concerned about current levels of excess capacity in the economy and the outlook for unemployment.
Prospects for the UK economy
The MPC is maintaining current GDP forecasts at +5% for 2021 and +7.25% for 2022 – although there is some uncertainty regarding unemployment. Recent data shows that UK GDP fell by 2.9% in January, which was weaker than expected. This may place pressure on short-term GDP performance, which expected to fall around 4% in the first quarter of 2021. However, on the plus side, the Bank of England expects an improvement in GDP forecasts at the May 2021 MPC meeting. So, there would appear to be a degree of short-term pain but more prosperous medium to long-term gains on the cards.
As ever, these forecasts come with a degree of uncertainty as much of the expected increase in economic activity is directly linked to the lifting of COVID restrictions. At the moment, the UK has one of the most successful vaccination programs. However, the recent threat to vaccination imports from India and the EU could see a temporary lull in vaccination numbers.
If we look at the international arena, the prospects look mixed. On the one hand, the EU vaccination programme appears to be in turmoil, which will impact the EU economic recovery. On the flip-side, Joe Biden, the USA president, recently confirmed a $1.9 trillion stimulus programme. The lifting of international COVID restrictions will impact more than ever UK economic growth in the short to medium-term.
Unemployment in the UK
The UK government recently announced an extension of the furlough support scheme, which will now end in September instead of April. While this has been welcomed by UK businesses, as the economy starts to open up, it means that unemployment may not peak until later in the year. The February meeting revealed that the MPC expects unemployment to peak at 7.8% during 2021 – they still appear to be standing by this figure. However, there is the potential for the economy to take up more “employment market slack” the longer the furlough scheme continues. A tricky balancing act set against inflation!
The most recent Labour Force Survey (LFS) showed an increase in unemployment to 5.1% in the three months to December 2020. At the moment, it is unlikely that the UK government will extend the furlough scheme beyond September. Although, as we have seen, nothing is ever certain during this COVID pandemic!
There has been much more focus on spare capacity during the latest MPC meeting. This is very important on two counts:
Even though the Bank of England has access to detailed economic data and powerful forecasting tools, reducing and eliminating spare capacity is difficult to predict with any great confidence. Indeed, the MPC commented that the outlook for the UK economy remains unusually uncertain in the short term. Much of the short-term recovery will come down to:
- Vaccination programme
- Consumer demand
- Business capacity
- Financial markets
Recent reports suggest UK households have saved more than £100 billion during the pandemic. The lifting of restrictions will release traditional pent-up demand. However, these vast savings should also create an additional economic boost.
Prospects for UK interest rates
It was no surprise to learn that the MPC decided against changing UK base rates, currently standing at 0.1%. Earlier this year, there was talk of negative interest rates if the economy took another hit. However, this talk seems to be diminishing. The main focus in the short to medium-term will be on UK inflation and the cost of government borrowing in the financial markets.
The yield on 10-year gilts increased by 0.05% to 0.9% after the release of March MPC meeting minutes. This is used as a barometer for the cost of future government borrowing and indicates upward pressure on interest rates. In comparison, at the time of the February MPC meeting, the comparable rate was 0.45%. All things being equal, expect to see less talk of negative interest rates and more talk of interest rate rises in the short to medium-term.
The Bank of England currently holds £875 billion of bonds purchased as part of the quantitative easing policy. Introduced to maintain liquidity during difficult times, the MPC decided to maintain the current limit at £895 billion. The scheme will need to be unwound at some point but is unlikely to happen in the short to medium-term.
Inflation in the UK
The 12-month Consumer Price Index (CPI) inflation figure is used to monitor changes in the UK’s cost of living. The CPI figure rose by 0.7% in January, which is well below the Bank of England’s target rate of 2%. Even though slightly subdued, inflation in the UK is expected to increase rapidly to around 2% in spring. The main fuel for this rise will be a reduction in excess economic capacity and potential unemployment rate improvements.
On the flip side, the MPC previously confirmed that in the event of a further downturn in the UK economy, they would consider “all options”. Many see this as an indicator that negative interest rates, while unlikely, have not 100% been taken off the table.
As inflation starts to rise again, this will eventually result in an increase in base rates, something not seen since 2 August 2018!
While many may see the release of yesterday’s MPC meeting minutes as something of a damp squib, they are surprisingly refreshing. Yes, there is short-term uncertainty for the UK economy, but the road to recovery is a little clearer. There will undoubtedly be bumps and diversions along the way, making it difficult for the Bank of England to make even short-term, let alone long-term predictions. The pace of recovery will, to a large extent, depend on the often fickle nature of consumer confidence.