MUNIX WEEKLY 4th February
‘No News is Good News’
On some occasions, not much happens, and that can be reassuring. Such is the situation today in relation to the Bank of England’s latest assessment on the state of the UK economy and its policy decisions. Tomorrow is another day.
The economic situation remains as dependent as ever on the virus, the vaccination programme, and eventually a hoped-for recovery in consumer and business confidence and spending. The UK is likely to experience another quarter of negative growth due to the lockdown, and then – if Andy Haldane is correct – rather stronger activity thereafter. Staycations are likely to be the order of the day this summer! At some point in late 2021 or early 2022, the Bank expects GDP to return to the pre-crisis level – other forecasters are rather less optimistic – albeit the scarring effects of the pandemic on the structure of the economy remain to be assessed.
On this basis, it is far too soon to decide on any changes to interest rates, QE programmes or any other policy decisions such as yield curve control. The headline writers will make much of the fact that the Bank of England has put active preparations in place so that it could set negative interest rates within six months. However, the important signal from the Monetary Policy Committee is that it does not consider such a move will be necessary. This conclusion was not a surprise after recent comments from various committee members. In effect, it is keeping a further tool in its box which can be used if circumstances change materially – for example the virus mutates into an even more dangerous version. The cost of borrowing or the availability of credit are not central issues in this global health crisis. Unsurprisingly, the immediate reactions in financial markets were limited, for example sterling edged up against the dollar and the euro.
The relationship between the policy decisions of the Bank and the Treasury will start to come under greater scrutiny as the Budget approaches on March 3rd. Last year, the Bank of England purchased over 120% of the annual UK government budget deficit. Through late January, the Bank had bought £757 billion of debt, with plans to buy £150 billion over calendar 2021, in relation to its current stock limit of £895 billion. Any signals from the Bank that it is adding to its QE purchases or conversely considering tapering of some form could have significant implications for the shape of the yield curve.
Meanwhile, the pressure of ‘excess liquidity’ in the financial system continues to bear down on interest rates across the world. The gilt yield curve has steepened modestly in the past week but yields remain flat out to about 2 years. Over in the USA, Reuters reported that there is a glut of cash in the short-term lending markets which recently took overnight rates down to zero, and risks pushing the Fed Funds rate into negative territory. The market is grappling with technical aspects of short-term bill issuance versus long-term bond issuance as well as changes in cash balances held at the US Treasury and the pace of monthly asset purchases. As outlined in previous weekly notes, cross-border capital flows are currently keeping all fixed income markets in a narrow trading range.
Andrew Milligan an independent economist and investment consultant. From 2000-2020 he was the head of global strategy at Standard Life/Aberdeen Standard Investments, analyzing the major financial markets for global clients. He currently assists a range of organizations with reviews of their investment processes, advice on tactical investing and strategic asset allocation, and how to include ESG factors into their decision making