“The Summer’s here and the time is right"
- David Bowie & Mick Jagger, Dancing in the Street
Despite the unseasonably inclement weather in the UK over recent weeks, there is a distinct air of Summer in global financial markets.
There is now a short window, between the July payroll data and the annual Jackson Hole Economic Symposium, where the markets’ Summer may well be in full swing. However, before we slip into some more brightly coloured clothing and reach for a pina colada, we would like to contemplate events a little closer to home.
Events were framed this week by the outlook and the Monetary Policy Committee (MPC) decision of the Bank of England (BoE). Going into the meeting, there was little expectation. The general consensus was that while there would likely be a dissent from certain MPC members on the continuation of QE purchases, that there would continue to be a comfortable majority in favour of the status quo. My bias going in to the meeting was that the debate would be much closer than expected, perhaps to the point of discussing a tapering of asset purchases - the problem with this being that as the BoE have announced a QE target, not simply a pace of purchases; slowing the pace would necessitate a longer purchase period (or an abridgement at a later date). Ultimately, while my hawkish bias may not have been mirrored in the MPC voting, it was very clearly represented in the bullish economic narrative (and upgraded forecasts that accompanied it).
The other (slightly more peripheral) debate ahead of this week’s BoE was around the sequencing of monetary policy - in short, when the time comes to normalise policy, should the policy rate or QE asset sales be the primary tool?. Some commentators had also been contemplating the outcome of the BoE review into policy sequencing. More specifically, was there likely to be any change to the previous BoE rule of thumb that the policy rate would have to rise to 1.5% before it could reduce the stock of asset holdings under QE.
Bear with me!
This is important, as the BoE view the stock of asset holdings as the monetary stimulus - not as is an alternative school of thought - the pace of purchases (driving cash into alternative investments). In this context, stopping QE purchases at this point when it has already been announced would effectively amount to a reduction in the ‘announced’ QE target and thus would be a tightening of monetary policy that could confuse the (already complicated) sequencing argument, and thus it is perhaps clearer that only one MPC member voted as such.
The statement was clear on a number of factors. Firstly, that the threshold for a QE unwind is now a Bank rate at 0.50% (the reduction is likely a function of the fact that the ‘operational’ inclusion of negative rates into the monetary toolbox). Essentially the 0.50% threshold only applies to the organic reduction of the asset holdings (stopping the reinvestment of expiring bond holdings) - active asset sales would not occur until Bank base rate hits 1.0%. Still a significant change - potentially quite a hawkish one.
Secondly, that the BoE continue to view inflation as transitory and expect it to rise to around 4% in Q4 2021 before falling back “close to target” - 1.89% at the three year horizon, based on the market expected rate path (currently Bank base rate around 50bps from its current 10bp - likely a 15bp hike to 25bps and then a 25bp hike subsequently).
Lastly, and most importantly in my view, the BoE Governor was clear to stress that the “BoE is more confident about the UK economic recovery”. To corroborate this view, the BoE released its updated projections for growth (unchanged at 7.25% in 2021, and raised to 6% in 2022) and unemployment, which it now sees falling to 4.75% by the end of 2021 and 4.25% by the end of 2022.
Finally, on that note, and before I sign off for a couple of weeks, the UK has also relaxed its international travel restrictions, with seven nations going from amber to green, one from amber-plus to amber and even four going from red to amber. If the UK can survive the rest of the Summer and the return to school relatively unscathed from the delta variant wave, then it is likely that the UK’s vaccination reopening ‘test case’, could be followed up in 2022 with a DM monetary normalisation ‘test case’.
There was no change in policy at the BoE meeting this week, there was no implicit guidance on the market pricing of rate expectations over the policy horizon, but from my perspective, this was a very significant policy meeting, and Monetary Policy Report (MPR). From the point of view of the Governor of the BoE, this kind of forecast adjustment is perhaps the most optimal for signing off for a short Summer break - maybe not quite dancing in the street, but certainly putting your feet up and reaching for a good book and a gin and tonic - not necessarily in that order!
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