The Bank of England monetary policy decision produced a rather unexpected result last week. While meeting expectations for a £100bn expansion in the Asset Purchase Facility, policymakers noted that economic data had been better than expected and slowed down the rate of weekly purchases from £13.5bn to £4bn. Furthermore, the Bank’s chief economist, Andy Haldane, voted against further asset purchases. Gilt yields unsurprisingly were jolted out of their downward trend, with the 10yr gilt yield rising nearly 10bps immediately after the decision as investors repriced monetary policy expectations.
It is unusual to suggest that an MPC meeting in which QE was boosted by a further £100bn was hawkish in tone, but policymakers appeared keen to highlight the more rapid global recovery than they had expected in May. For most policymakers, this faster rise in output was not enough to deter further easing, but for Haldane, the accommodative policy already employed was enough to return inflation to target over the forecast horizon. Taken together with the slower pace of purchases, this rise in QE had an air of finality to it, challenging market expectations that monetary policy would loosen ad infinitum.
This is a rather interesting viewpoint. In May the Bank of England produced an Inflation Report excluding the traditional fan charts for growth and inflation, most probably because the level of uncertainty was so significant producing something usable was nigh on impossible. Instead the bank produced an illustrative scenario. In May the opinion was that it was better to ease policy too much than do too little. Just one month later, policymakers appear more relaxed about both the future outlook and the level of policy necessary to support growth/inflation expectations.
Admittedly the data has been better than expected, but, equally, we did not really know what to expect. UK GDP growth declined 5% in March and 20% in April, which cumulatively was less than the Bank had pencilled into its projections. Spending also appears to have recovered more quickly than expected in May, indicating that the drop in Q2 growth will not as significant as projected in the May Monetary Policy Report.
But the contraction will still be the biggest on record and will have long lasting repercussions. This is noted in the minutes and it is the uncertainty about the strength of this medium-term impact that prompted most MPC members to press the QE button once more. There is clear concern about the impact of the virus on the labour market. We concur and unfortunately foresee another sharp rise in unemployment as the government support is eased and some of those furloughed are made redundant. Similar to the financial crisis, the fear of unemployment will weigh on earnings growth and therefore limit household spending.
Was there more behind the tone and Haldane’s decision than purely the economic data? It is perhaps more understandable if we see current monetary policy as intervention to ease stresses in the financial system. As the minutes noted, liquidity in the gilt market had normalised, repo rates were close to Bank Rate and corporate spreads had fallen, lessening the need for further policy easing. There is also the question about what further monetary easing in current conditions can achieve – Bank Rate is already close to zero, risk free rates are at or below Bank Rate, policy expectations are low, the yield curve is shallow. In these conditions it makes more sense for the Bank to keep its powder dry, intervening as necessary when it perceives expectations to be moving away from the desired position. An informal yield curve control.
There are yet further questions about the impact of monetary policy on social issues, including inequality. If you take the view that QE boosts asset values rather than economic growth, then further QE is undesirable, only to be employed if money is growing too slowly or not growing at all, to avoid excess liquidity boosting the wealth of asset owners to the detriment of those without.
Whatever the reason, we expect the Bank and the UK government will need to do more to support the economy as the economic impact of the lockdown and the deterioration in household and business confidence is felt in the coming months. While the sharp fall in output was not a severe as initial projections suggested, it was still unprecedented in its severity and the repercussions will be some time in developing. At the very least, QE can be seen as desirable if only to hoover up gilts issued by the government to fund support packages and keep the costs of servicing the outsize debt in a manageable range. We expect this will not be the last tranche of QE we see in the UK.