Bank of England Preview

The Bank of England wraps up its meeting tomorrow. It is widely expected to remain on hold whilst likely setting the table for further easing by year-end. Below is a list of what the BOE may or may not do.

RECENT DEVELOPMENTS

BOE officials have already tilted dovish ahead of this meeting.  Deputy Governor Ramsden, Governor Bailey, and MPC member Vlieghe appeared before parliament earlier this month and delivered a fairly downbeat outlook for the economy.  Ramsden noted that “We have headroom to do materially more quantitative easing if we need.”  Bailey noted risks to growth remain to the downside, while Vlieghe warned “There is a material risk in my view that it could take several years for the economy to return to full capacity and inflation to return sustainably to target, even with monetary policy at its current settings.” MPC member Saunders recently said,  “I consider it quite likely that additional monetary easing will be appropriate in order to achieve a sustained return of inflation to the 2% target.”

The Bank of England is looking at headwinds ahead as the government’s job furlough program ends next month. Chancellor Sunak is coming under pressure to react to the recent job redundancy figures and he has made some vague comments about tweaking the furlough scheme. Sunak provided no details about what’s on the table, aside from saying that they will be “creative” in supporting the job market. But if the recent communication can be taken at face value, extending the furlough scheme (in its current form) is not going to happen. The cynics in us suspect that these are trials balloons and in part a way to distract from the Brexit showdown and widespread criticism towards the Johnson administration.

The bank also sees headwinds from rising risks of a potential no-deal Brexit. The EU has given the UK until the end of this month to withdraw the controversial Internal Market Bill.  If not, legal action has been threatened.  However, the Johnson government is still going full speed ahead, with the bill approved in its second reading in Parliament this week despite a sizable rebellion. The next test will be the Neill Amendment, expected to hit the floor next week. The amendment would allow parliament to veto any change to the Withdrawal Agreement. The House of Lords could also amend the bill, passing it back to the House of Commons for further discussion. In short, there is still a long way to go before this bill becomes law but if it does, the EU is likely to walk away from current trade talks.

 

WHAT ELSE CAN THE BOE DO?

While no action is expected today, we outline some possibilities. Recall that at the June 18 meeting, the Bank of England increased its asset purchases by GBP100 bln to a total of GBP745 bln. However, it signaled a slower pace of purchases. The vote was 8-1, with Chief Economist Haldane dissenting in favor of no change. At the August 6 meeting, the BOE delivered a less dovish than expected hold and presented a fairly upbeat outlook. The vote to keep policy steady then was unanimous. Recent comments suggest that upbeat outlook has been replaced with a more realistic one. There are several other moves that the BOE could make in the coming months if needed.

  1. Tweak its forward guidance – POSSIBLE NOW, POSSIBLE IN Q4. At its most recent meeting August 6, the BOE left policy unchanged whilst saying “The Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit. The MPC will keep under review the range of actions that could be taken to deliver its objectives. The Committee 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.” It’s possible that the bank changes its statement tomorrow to acknowledge that further easing may be needed, rather than just saying it won’t tighten anytime soon. At the August meeting, it said the recovery was recovering faster than it initially forecast. Updated forecasts were presented, with GDP seen contracting -9.5% for 2020 before growing 9% in 2021 and 3.5% in 2022. The forecasts were more optimistic than those issued in May, including a -14% drop this year.
  2. Increase existing asset purchase programs – UNLIKELY NOW, LIKELY IN Q4. Since the BOE just delivered a GBP100 bln increase in June, another increase now seems too soon. With budget deficits and gilt issuance likely to rise even further due to more fiscal support to be seen this fall, we think another increase in QE by year-end is a given. We expect some dissents today in favor of expanding QE immediately, which sets the table for an actual expansion at the November 5 meeting. New macro forecasts will be released then and are likely to provide cover for more stimulus.
  3. Tweak its lending programs – UNLIKELY NOW, LIKELY IN Q4. The BOE introduced a new Term Funding Scheme with additional incentives for small- and medium-sized enterprise (TFSME) March 11, when it also cut the bank rate 50 bp to 0.25%. The scheme provided 4-year funding at a rate close to the newly lowered bank rate. The amounts were limited to 5% of total lending, but additional funding is available to banks that boost loans to small- and medium-sized enterprises. TFSME was enlarged on March 19, when it also cut the bank rate 15 bp to the current 0.10%. Both the rates and the limits could be adjusted to provide more lending.
  4. Introduce Yield Curve Control – UNLIKELY NOW, UNLIKELY IN Q4. Much of the BOE’s attention appears to be on negative rates, though officials stress that all options are being studied. We think the main reason why Yield Curve Control (YCC) remains outside the central bank’s public dialogue yet that the market is already doing the heavy lifting for it. The entire UK curve out to 6 years is now negative in anticipation, while the short sterling futures is pricing in a negative policy rate starting next September.  Furthermore, the 10-year yield is currently around 20 bp. This means the UK gilt curve remains very low and very flat, which is exactly what YCC would achieve. If perceived improvements in the UK economy were to push UK yields significantly higher, then we think YCC would become more likely. It’s worth noting that continued BOE talk of negative rates (see below) is likely contributing to low UK rates across the curve.
  5. Negative interest rates – VERY UNLIKELY AT ANY TIME. At the last meeting August 6, Governor Bailey said that negative rates are in the bank’s toolbox but there are no plans to use them. The bank could theoretically still cut rates 10 bp to zero, but we do not believe the UK economy is built to withstand negative rates. Why not? The financial sector is a large part of the UK economy. This sector is already at risk from the prospects of a hard Brexit, and so the last thing it needs is negative rates that would further harm profitability and distort lending and borrowing incentives. Some analysts are calling for negative rates in the case of a hard Brexit, but we think such a move would simply compound the problem for UK banks.

 

INVESTMENT OUTLOOK

Poor fundamentals and ongoing Brexit risks have kept sterling underperforming this year. So far in 2020, sterling is -2% and is ahead of only the worst performing major NOK (-3%). After trading at the highest level since December near $1.3480 on September 1, rising Brexit concerns have weighed on sterling. Support was seen just ahead of the 200-day moving average near $1.2735 currently, and cable is getting some limited traction. We need to see a break of the $1.3125 area to signal a stronger recovery back towards the $1.3480 high.

Sterling has a mixed record on BOE decision days.  Of the seven this year so far, it has risen against both the dollar and the euro on four and fallen on three.  While we remain skeptical that the BOE will go negative, the subdued interest rate outlook and no-deal Brexit risks should continue to weigh on sterling.