The Times – How Bank of England dropped clues that tightening may be next big idea

Philip Aldrick, Economics Editor
Friday February 05 2021, 12.01am, The Times

https://www.thetimes.co.uk/article/how-bank-of-england-dropped-clues-that-tighte
ning-may-be-next-big-idea-rhqndq9zt

At first glance, nothing happened at this month’s Bank of England rate-setting
meeting. On closer inspection, though, it may have been one of the most
important monetary policy committee events in years.

The big issue was not the base rate, which remained at 0.1 per
cent or quantitative easing, unchanged at £895 billion, but the
policy toolkit of the future.

In six months’ time, at the August meeting, negative rates will be a genuine
policy option for the first time in Britain. High street lenders will be ready
to pass them on, the Bank has said. A system of “reserves tiering” to offset
some of the damage to bank profits by negative rates – Natwest says that a cut
to -0.15 per cent would cost it £450 million – will be in place.

If the MPC then decides it wants to follow Sweden, Denmark, Switzerland, Japan
and the eurozone in taking rates below zero, it can.

Yet negative rates were not the only piece of the policy toolkit on the
committee room table. The Bank also has begun “to reconsider previous guidance
on the appropriate strategy for tightening monetary policy should that be
required in the future”.

The present arrangement is that the QE programme will not be altered until
rates are at 1.5 per cent. Policymakers now want to establish whether they
could start to unwind it before raising rates.

Andrew Bailey the governor, emphasised that the
reviews were not a policy signal and said that announcing them together was a
smart way of managing that communication. Negative rates would be easing,
selling QE early would be tightening. If it was a signal, it was contradictory.

The clear inference from the monetary policy report, with its bullish view of
the recovery, was that tightening is far more likely than loosening. Martin
Beck, UK economist at Oxford Economics, the consultancy, described the Bank’s
stance as “a hawkish tilt” and markets agreed. Traders pushed out the date for
negative rates from August to next February, which drove the pound up 0.7 per
cent against the dollar. Ten-year gilt yields climbed to their highest level
since November.

The clues to potential tightening were trailed like breadcrumbs through the
Bank’s releases. The MPC minutes said that the committee “did not intend to
tighten monetary policy at least until there was clear evidence that
significant progress was being made in eliminating spare capacity and achieving
the 2 per cent inflation target sustainably”.

Flick across to the Monetary Policy Report and it said that those objectives
would be achieved within 12 months. “Spare capacity . . . is eliminated as GDP
picks up during 2021 . . . [which] results in a small margin of excess demand
emerging by the end of the year,” the report says. From then on, there is no
spare capacity. Supply and demand are “broadly in balance”.

As for prices, the Bank expects inflation to rise just above the 2 per cent
target by the start of next year and to stay there. The only distinct obstacle
to policy tightening by then is unemployment, which still will be elevated, at
5.7 per cent, in early 2022.

On any normal judgment, the Bank’s central forecasts are positioned for a rate
rise – or QE unwind instead – not a rate cut into negative territory. If
anything, its central forecasts may be understating the pace of the recovery.

Households were sitting on £125 billion of excess savings in November. That
will have increased in the present lockdown as evidence shows people save when
much of the economy is closed. Yet the Bank expects only £6.25 billion of the
£125 billion to be spent.

Bailey said: “There is a risk that it could be larger. So it’s an upside risk.”
The downside risk is that Covid variants mutate faster than vaccines can keep
up.

The Bank’s analysis also highlights the problem of rising inequality. Average
wages have risen because lower-income workers are more likely to be those who
have lost their jobs.

Unemployment remains at today’s level of 5 per cent in 2022, having peaked at
7.75 per cent later this year after furlough is removed. That suggests half a
million fewer people in work than before the pandemic.

Yet the Bank’s job is to keep inflation under control and, for all the
excitement about negative rates, it’s the humdrum review into unwinding QE that
may be more significant.

Inflation Report in brief

Decision
The nine ratesetters on the monetary policy committee were unanimous in voting
to hold rates at 0.1 per cent. They also left the stock of QE unchanged at £895
billion and announced that they had begun technical work on whether to unwind
quantitative easing before raising rates. The Bank also shared findings from
its review of negative rates, concluding that they are operationally feasible

Growth
The economy is likely to have escaped a double-dip recession by eking out
growth in the final quarter of last year. The first quarter of 2021 will be
more challenging, with output expected to fall by 4 per cent. The economy will
not return to its pre-pandemic size before the first quarter of 2022

Unemployment
Joblessness will rise from its present rate of 5 per cent to peak at 7.75 per
cent by the middle of this year. It will then fall to 5.7 per cent by the start
of 2022

Inflation
Prices will start to increase sharply later in the year, when the inflation
rate will rise to 1.6 per cent. The present level of inflation is 0.6 per cent

Main message
Although the country should enjoy a rapid vaccine-fuelled rebound later in the
year, there are several risks that could threaten the recovery. The Bank could
impose negative interest rates if more support is needed

 

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