September BoE MPC Preview: Unemployment – the lull before the storm

September 15, 2020

Thursday’s BoE MPC announcement is expected to see the main policy levers being left on hold. However, recent dovish comments from at least three MPC members have boosted the chances of the QE bar being raised again even if, for now, the Bank is not convinced about the value of cutting Bank Rate (0.10 percent) any further. Policy was last eased in June when QE was raised by £100 billion to £745 billion, although within this there was an implicit reduction in the monthly purchase rate. At the current pace of about £4 billion/month, the ceiling should be hit around year-end.

The vote for no change in July was passed unanimously and August’s outcome looks likely to be the same. Even so, there are clear differences of opinion over current economic conditions. Just last week, the BoE’s Chief Economist Andy Haldane (the sole dissenter in favour of not easing in June) was talking up the UK economy and suggested that the “recovery isn’t being given enough credit.” By contrast, his MPC colleagues Michael Saunders, Gertjan Vlieghe and Deputy Governor Dave Ramsden have all recently warned that the recovery could take longer than incorporated in the Bank’s latest baseline scenario. For the doves, the main issue would seem to be the labour market and the clear risk that unemployment will rise sharply once the government’s Job Retention Scheme (JRS) has ended next month. Some 9.6 million employments (32 percent of total eligible employments) had been furloughed through the JRS for at least part of the period between March to June. Indeed, a Treasury Select Committee has just called for a targeted extension of the JRS or face mass unemployment and watch viable firms going bust.

This programme has played a major part in holding down the unemployment rate which was still as low as 4.1 percent in the three months to July. However, leading indicators of employment have turned very negative; notably vacancies which fell to a record low in the second quarter and have not recovered much since. The MPC’s own forecast is for the jobless rate to climb to 7.5 percent and even that is comfortably below many private sector projections. To this end, the BoE’s August Decision Maker Panel survey found businesses estimating that Covid-19 would reduce their overall employment levels by 7 percent this quarter and 8 percent next versus what would have been the case without the pandemic. Early indications for August from Pay As You Earn (PAYE) Real Time Information (RTI) have indicated that the number of payroll employees fell by some 695,000 (2.4 percent) compared with March. Still, central bank Governor Andrew Bailey is on record as supporting the termination of the furlough scheme in October.

More broadly, the economic recovery to date has been somewhat faster than generally expected. Even so, the rebound has been from an exceptionally weak base and real GDP in July was still nearly 12 percent below February’s pre-lockdown mark. The key services sector was some 12.6 percent short. In fact, the economy at the start of this quarter was only operating at the same level as in April 2013 and with businesses predicting further hefty declines in investment spending through at least year-end, longer-term productive potential is being steadily eroded. That said, there have been some bright spots. Household demand has picked up particularly sharply despite historically weak consumer confidence and retail sales volumes in July were already back above their pre-pandemic level. Similarly, activity in the housing market has accelerated rapidly and most of the major surveys now show average house prices at record highs.

However, the bounce-back in demand has not given much of a boost to consumer prices and CPI inflation remains stubbornly below its 2 percent target. On balance, Covid-19 effects appear to have been negative. In fact, the combination of a weakening labour market and furlough effects has prompted an even steeper decline in wages growth which in May-July posted its second lowest outturn in more than a decade. The upshot is that real earnings are now being squeezed significantly and that before the anticipated surge in unemployment has even got started. Against this backdrop, the current relative buoyancy of consumer spending could easily prove short-lived.

Ultimately though, the biggest threat to the economic recovery still comes from Covid-19. New cases have risen sharply since August and the average daily infection rate is now running at levels not seen since May. As a result, new nationwide restrictions on group meetings came into effect yesterday, compounding the localised regional lockdowns already in place. The new measures are expected to last several months and will inevitably have some dampening impact upon economic activity.

The coronavirus may be the number one risk but an increasingly close second is the latest twist in the Brexit saga which last week saw the UK government introduce new legislation (the Internal Market Bill) that would allow ministers to nullify parts of the withdrawal agreement in the event of there being no trade deal. Whether simple politicking or not, the move can only sour UK-EU relations and boost the likelihood of a (possibly hugely) damaging no-deal Brexit just when the economy can least afford it.

In sum, Thursday’s announcement will most likely leave policy on hold but an increasingly uncertain economic outlook means that the MPC may well prepare some of the groundwork for a new ease at the next meeting in November. By then, QE will be approaching its ceiling and, unless it has been extended, the early effects of ending the furlough programme will be incorporated in an updated Bank economic forecast. The importance of the jobs market to policy was highlighted in the August MPC’s modified forward guidance which signalled no tightening “until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2 percent inflation target sustainably.” This has raised the standing of the monthly labour market report in general and, as a proxy for excess capacity, of the unemployment rate in particular. And looking up, the clouds are starting to gather.