Surprise dovish tilt: Ahead of an uncertain election, and with Brexit still unresolved, the Bank of England has tilted more to the dovish side than expected. The surprises in its November Monetary Policy Report include a large downgrade to the growth and inflation outlook, dissents in favour of a rate cut by two policymakers, and a significant change in forward guidance. While the BoE is still guiding markets towards hikes if the downside risks to the UK economy do not materialise and growth picks up in line with the BoE’s forecast, the overall tone of the November Monetary Policy Report suggests that policymakers are more worried about the prospect of a more protracted slowdown than before.
Forward guidance goes from hawkish to almost neutral (on balance)
The BoE has softened its message from previous meetings. The November minutes state that if the ‘risks did not materialise and the economy recovered broadly in line with the MPC’s latest projections, some modest tightening of policy, at a gradual pace and to a limited extent, might be needed’. This is softer than in September when the minutes stated that ‘increases in interest rates, at a gradual pace and to a limited extent, would be appropriate’. Notice the shift to ‘might’ from ‘would’. Second, the latest minutes also include that ‘if global growth failed to stabilise or if Brexit uncertainties remained entrenched, monetary policy might need to reinforce the expected recovery in UK GDP growth and inflation’ – thereby hinting at potential rate cuts.
Two MPC members (Jonathan Haskel and Michael Saunders) voted in favour of a 25 bps cut in the bank rate at the November policy meeting. That Saunders, a known hawk, dissented is significant. He was a front-runner to the two hikes of the past two years, in November 2017 and August 2018.
In our view, a near-term rate cut still seems unlikely as long as the Conservatives win a majority at the upcoming election on 12 December. The Conservative Party plans to deliver an orderly Brexit on 31 January 2020 and enact large tax cuts and increased spending that should lift demand growth and inflation (our base case). However, until the election has happened and parliament actually passes such fiscal plans, the BoE will not incorporate them into its economic forecasts. The BoE reacts to fiscal policy, it does not act pre-emptively ahead of elections or potential – even if likely – policy changes. As a result, we expect the BoE to revise up its economic forecasts and return to a more hawkish tilt after the election.
Take the forecast revision with a pinch of salt
On balance, the BoE is more pessimistic about the economic and inflation outlook than in August. However, the seemingly large revisions overplay the downgrades to the underlying economy. In August, financial markets had worried a lot about the risk of a no-deal Brexit. Reflecting this risk, sterling and yields across the gilt curve were much lower than they are today. The BoE conditions its projections on the market’s forecasts of these asset prices. The market now sees a much lower risk of a hard Brexit. In the press conference today, Governor Mark Carney described a hard Brexit as a ‘tail-risk’. 10 year yields are some 30bps higher than the August low while trade-weighted sterling is up by roughly 7%. The BoE’s downgrades to its projections for growth and inflation partly reflect this sizeable tightening of financial conditions.
Furthermore, the BoE has changed its conditioning assumption for Brexit. The Monetary Policy Report notes that ‘Since the August 2016 Report, the MPC’s projections have been conditioned on the assumption of a smooth transition to an average of possible end-states, with the adjustment taking place gradually over many years. Consistent with the provisions of the Withdrawal Agreement, the MPC’s latest projections are now conditioned on the assumption that a greater proportion of the adjustment to the UK’s new trading arrangements with the EU takes place within the three-year forecast period.’ The new assumption implies a more front-loaded adjustment to slower trend growth as a result of Brexit.
Taking these factors together, of the roughly 1% reduction in real GDP by the end of the forecast period versus August, the BoE notes that ‘three quarters.. is accounted for by the moves in asset prices and the weaker global environment…..the remaining quarter can be accounted for by the net impact of the changes to the MPC’s Brexit conditioning assumption’ and ‘the fiscal measures announced in Spending Round 2019.’
Summary of MPC policy decisions
At its meeting ending on 6 November 2019, the MPC voted:
| by a majority of 7–2 to maintain Bank Rate at 0.75%; |
| unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion; and |
| unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion. |
Policy outlook
For our economic base case, we expect Prime Minister Boris Johnson and the Conservative Party to win a majority of seats at the election. That should enable an orderly Brexit to happen on 31 January next year. In line with the MPC’s latest guidance, we look for the BoE to hike the Bank Rate in Q3 2020 followed by another hike in 2021, by 0.25bp each time. That would take the bank rate to 1.25% by end-2020. Of course, if the election ends in a hung parliament the BoE would change its tune fast and, could, as signalled in the updated guidance, even cut rates.
Kallum Pickering
Senior Economist
Phone +44 203 465 2672
Mobile +44 791 710 6575
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