BoE in “steady-as-she-goes” mode

Emily Nicol
Chris Scicluna

BoE less dovish but won't get carried away:
This morning the BoE’s MPC inevitably voted unanimously to leave Bank Rate unchanged at 0.1% and also left its asset purchase target unchanged at £745bn. But it rewrote its guidance on the likely direction of future policy, becoming significantly less dovish in the process. Indeed, having previously signalled a clear easing bias, this time the MPC was equivocal about the most likely direction of the next move in policy. And as a result, sterling has strengthened, with EURGBP back below 0.90. But an initial sell-off in Gilts has quickly reversed, with bond investors recognising that it would be unwise to anticipate any move to tighten for the foreseeable future.

While the MPC acknowledged the unusually high uncertainty about the economic outlook, the BoE’s updated central projection suggests that, in two years’ time, inflation will have returned to target and will be rising, with economic activity back above its potential level too. And so, while the MPC noted that the risks to the growth outlook remain skewed to the downside, for the time being it no longer seems inclined to provide additional stimulus.

At the same time, the MPC underscored that any moves to reverse recent policy stimulus remain some way off, stating that it “does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably”. So, the MPC appears now to be in “steady-as-she-goes” mode.

Certainly, Bank Rate is highly unlikely to be amended for some time to come. And in terms of QE, from next week until mid-December, the BoE’s asset purchases will slow to a weekly average of £4.4bn (down from £6.9bn over the past five weeks). The MPC’s statement suggests that, if the recovery in economic activity continues in line with the BoE’s projection, net purchases will not be extended into next year.

But if recovery momentum peters out, unemployment jumps more than the BoE expects, and/or underlying inflation weakens further, the BoE would still seem likely to take new action. And that would almost certainly take the form of an increase in the asset purchase target, with any more unconventional action still unlikely. Indeed, the BoE’s latest Monetary Policy Report makes clear that negative rates at this time could be less effective as a tool to stimulate the economy given their impact on the banking sector.

In terms of economic conditions, the BoE judges that UK GDP dropped to a level more than 20% below the pre-Covid peak in Q2, a performance that might represent the worst of all major economies. But it also takes comfort from higher-frequency indicators, which imply that spending has recovered significantly since April’s trough. Nevertheless, the BoE still expects conditions in the labour market to continue to deteriorate over the near term, and the unemployment rate to jump to around 7½% by year-end. And it expects inflation to fall further and average around ¼%Y/Y towards the end of 2020 too.

However, assuming no major second wave of pandemic and an orderly move to a comprehensive free trade agreement with the EU at the start of 2021 – neither of which, of course, can be taken for granted – the BoE expects recovery to be sustained and unemployment to start to decline next year, so that the Q419 level of activity is reached by end-2021. And given an extremely dim view of the UK’s supply potential, it estimates that inflation will be back to the 2% target and rising, with activity above trend, in two years’ time.

With excess demand unlikely to generate significant price pressures, however, even assuming that output continues to rise further above potential and unemployment falls back down to 4% or below in 2023, the BoE would expect inflation only to move slightly above target – to 2.2%Y/Y – in three years’ time, suggesting little need to tighten policy even in such an optimistic scenario.

Due to concerns about the path of the pandemic and its impact on spending when the weather turns for the worse in the autumn, as well as the damaging impact on business investment of Brexit-related non-tariff barriers to trade, our view on GDP and unemployment is more downbeat than that of the BoE. And so, we continue to see a significant risk that further policy accommodation – via an additional £100bn slug of asset purchases in 2021 – will eventually be required, with an announcement of such action as soon as the November MPC meeting still not to be ruled out.

German factory orders significantly beat expectations:
While last week’s German Q2 GDP estimate came in weaker than expected, today’s factory orders data for June suggest that the country’s economic recovery will be far more V-shaped than many of its peers. Certainly, the 27.9%M/M surge in orders that month came in well ahead of expectations and followed an increase of almost 10½%M/M in May, likely reflecting an anticipated boost to domestic demand prompted by the VAT cut last month. Of course, this came on the back of a significant plunge in the spring as lockdowns were introduced – indeed, manufacturing orders were still 11½% below February’s pre-pandemic level and down more than 10½% compared with a year earlier.

Within the detail – consistent with the view that the government’s stimulus measures have been key – growth in domestic orders continued to drive the recovery, up more than 35%M/M, to take them back above the pre-pandemic level. But while orders from overseas – both within the euro area and elsewhere – were also more dynamic in June, up around 22%M/M, they were still down by more than a fifth compared with February’s level.

Among the sectors, the strongest growth in orders was again registered in motor vehicles (66½%M/M), with strong demand from at home and overseas. Indeed, the level of domestic motor vehicle orders in June returned back to the pre-pandemic level. Growth in other sectors was somewhat more modest – orders of metals were up 17.8%M/M, electronic items up 13.3%M/M and chemicals up 4.9%M/M. When excluding major items, the improvement was slightly less pronounced, with the near-24%M/M increase leaving the level of orders still 15% below the pre-pandemic peak.

Meanwhile, manufacturing turnover rose a more modest 12.6%M/M in June to be still down 15.6% from February’s pre-pandemic level. And so, while tomorrow’s manufacturing production figures will likely see another solid increase in June, the level would still seem bound to remain well down on February’s level.

Today’s US data:
Ahead of tomorrow’s BLS labour market report, this afternoon will bring Challenger job cuts figures for July, as well the latest weekly jobless claims figures.

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