August BoE MPC Preview: Counting the cost of Covid-19

August 4, 2020

Thursday’s BoE MPC announcement is expected to leave financial markets largely undisturbed. Policy was eased further at the last meeting in June when the ceiling on QE was raised by £100 billion to £745 billion and the likelihood is that, on balance, the MPC will be happy to sit back and give time for the latest measures to work. However, no change is not a done deal as uncertainty about the economic outlook remains as high as ever and the Bank is clearly worried about the potential damage to the recovery that a near-certain rise in unemployment will inflict over coming months. In addition, the August deliberations will be accompanied by an updated Monetary Policy Report (MPR), the release of which is typically used to provide the fundamental justification for any shift in stance.

The July vote on increasing QE was passed 8-1 with chief economist Andy Haldane the sole dissenter favouring no change. As it is, the pace of QE has already been reduced significantly, now running at around £7 billion a week or about half the rate prior to the June meeting. At this pace, the new £745 billion ceiling should be reached by the end of the year.

Meantime, while speculation about negative interest rates has not gone away altogether it has been pushed further out. Since BoE Governor Andrew Bailey set the ball rolling back in May when he was quoted as saying that the issue was “under active review”, official word on the subject has taken a step back. That said, just last month external MPC member Silvana Tenreyro was talking up the positive effects of sub-zero rates in the Eurozone and other countries so Bank Rate (currently 0.10 percent) could yet be cut again depending upon how the economy performs going forward.

In recognition of the near-impossible task of forecasting economic trends while the coronavirus crisis is still with us, the May MPR saw the BoE opt to issue what it called a ‘plausible illustrative economic scenario’ based on a set of stylised assumptions. This showed real GDP contracting a record 25 percent in the second quarter and some 14 percent during the calendar year before rebounding by 15 percent in 2021. This profile left total output still short of its pre-lockdown level until 2022 and helped to ensure that inflation remained below target until well into that year.

Since then, the actual data have been mixed but, in the main, probably a little stronger than the MPC anticipated. In particular, consumer demand has recovered very quickly and in June retail sales volumes were only fractionally short of their pre-lockdown level. The labour market has also deteriorated more slowly than the MPC expected. Consequently, second quarter GDP now looks unlikely to have shrunk by as much as contained in May’s MPR. Even so, consumer confidence is still weak and planned purchases remain historically very low. Moreover, the bounce-back in the goods producing sector has been only modest and with the government’s Coronavirus Job Retention Scheme scheduled to close on 31st October, employment, income and spending could all be hit. Indeed, what happens to fiscal policy in general will have an important impact on where monetary policy goes from here.

In any event, the future path of the economy is heavily dependent upon the extent to which the coronavirus impacts the willingness of employees to return to work, the scope for firms to take back staff within the framework of the social distancing rules and the propensity of the consumer sector to spend. All of which can only be guessed. The key headline Covid-19 statistics have fallen sharply since their peak in April but the latest data warn that the easing of lockdown restrictions may have put a floor under both new cases and deaths. Indeed, a marked increase in new cases saw fresh restrictions being introduced in parts of northern England at the end of last week, potentially affecting some 4 million residents. More of the same and there would be a very real risk that the economic recovery peters out well before anything like a return to normal levels of output has been achieved.

The BoE has already done a lot but it has also indicated that it will do whatever is necessary to combat the economic fallout from the coronavirus. This is just as well because until a long-term solution to beat the virus has been found, the real cost of Covid-19 will remain incalculable. So, for now, monetary policy will need to remain very flexible, nimble and, quite probably, prepared to go even further into uncharted waters.