"Delete the negative, accentuate the positive"
- Donna Karan
As I looked at the backdrop for GBP and UK rates in the run up to the Bank of England (BoE) meeting this week, I had thought that a lyric from the Nirvana song ‘Negative Creep’ may be apposite. As it turns out, Donna Karan summed up my thoughts more aptly!
Though expectations for policy change were broadly centred around the May meeting – be it through rate cuts or further quantitative easing (QE) – going into this week’s meeting there was much debate, not just about the prospects of negative interest rate policy (NIRP), but the proximity of the lower bound and the extent of the potential dissent, particularly from the internal members, who were deemed to be less open to the prospect of negative rates than the external members.
What we got from the BoE was both less enthusiasm about the prospects for NIRP and a more constructive view on the prospect of an economic trajectory that, after a (lockdown induced) contraction in Q1, recovers “rapidly towards pre-Covid levels over 2021”. Furthermore, during the press conference, the Governor was clear to point out that the announcements made surrounding the use of negative rates were in no way intended as a policy indication or market signal, and that it was simply the result of the review that NIRP could be used if required at some point in the future – although not within the next 6 months for reasons of operational readiness.
On the economic front, there were also some interesting narratives. Firstly, the UK economy performed better than expected in Q4 than was forecast at the September meeting (now likely to report modest positive growth for the quarter). In addition, there were some further signs that, while the lockdown will clearly generate negative growth in Q1, the economic impact of lockdown had attenuated from the spring. This is alongside a general sense that people’s behaviour, and thus economic activity, has adapted to the lockdown this time round. It is also worth noting that the BoE still see the return to pre-Covid levels by the end of the year, and thus anticipate a “rapid” recovery starting in Q2 – in large part due to the successful rollout of vaccines – and even noted upside risks to the forecasts through a faster run down of accumulated ‘lockdown savings’ when the economy reopens.
From my perspective, this also has important policy implications. If policymakers expect the economy to rebound rapidly from Q2, then there is a sharply reduced likelihood for the need for further monetary accommodation in Q3 (post the 6m operational notice for QE). Indeed, the BoE Governor also appeared very sanguine about the implications of trade frictions from Brexit, in that he was clear that the BoE forecasts from November incorporated two quarters (reducing over time) of adjustment to the new trading relationship – despite the fact that the Brexit agreement was not reached until 24th December – noting, “there has been nothing so far to make us change our assumptions.”
Lastly, there was a discussion of the trajectory of the unemployment rate and business investment, as the UK recovery evolves over 2021. The assumption is that the peak in unemployment remains at 7.5% (from the current 5%), delayed by the further extension of the furlough scheme, but not raised by the third iteration of UK lockdown. Business investment, however, was deemed likely to return at a slower pace than consumption expenditure, and the BoE Governor was very clear that business investment was a very high priority, having been weak for quite a long time, and key to underpinning growth and the Covid recovery. Interestingly, pre-Covid, there always remained a debate about renewed business investment, once the trading and regulatory relationship between the UK and EU was known after Brexit – perhaps the ‘opportunities of Brexit’ are an upside risk to business investment. Either way, judging by the quality of the audio on today’s BoE virtual press conference, a strong case could be made for the BoE to do some business investment of its own!
In sum, I am minded to view today’s Monetary Policy Report as something of a watershed. The review into the use of negative rates in the UK resulted in the inclusion of NIRP in the monetary policy toolbox, but only alongside the statement from the Governor that they “did not wish to send any signal that it intended to implement NIRP at any point in the future”, merely that they were “adapting the monetary tool kit to a world of larger shocks”. Indeed, the Deputy Governor for Markets and Banking also alluded to the likelihood that the BoE will need to slow the pace of QE purchases “somewhat at some point” in 2021. From my perspective at least, it remains unlikely to be used. That does not mean that it doesn’t play an important role in maintaining the symmetry of Bank policy options (practically important in preventing an unwanted floor in long end rates and curve).
Against the complicated backdrop of the global economy, we see this as a continued positive for GBP, with a preference vs EUR rather than USD at the current juncture – not least in the near term, as positioning and expectations are adjusted to remove the prospect (and potentially significant implications) of negative rates. In many respects, you could categorise today’s meeting as demoting (if not deleting) the negative and accentuating the positive!
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