MUNIX COMMENTARY – WEEK OF 3 May
The Bank blinks
I ended last week’s note by saying: “the economic backdrop is moving rather faster than usual. Business surveys in March and April definitely show a sharp improvement in household and business sentiment as the lockdown ends. Economists are busy upgrading their forecasts for how strongly the UK economy could grow this year, with estimates of 5-6% moving towards 7 or even 8%. In May, or August, or November, the MPC itself may start to give hints that its asset purchase programme need not continue at the same rate. As normal market supply and demand factors begin to appear, so should the true price of debt”.
This week’s Bank of England meeting confirmed most of those statements.
It was no surprise that the MPC has raised its forecast for economic growth in the UK in 2021. Not only is there evidence of a strong rebound in consumer spending as the lockdown ends, helped by pent up demand, plentiful household savings and a degree of largesse from the Chancellor in his March Budget, but also the international environment is far more favourable – helped especially by very easy fiscal policy in the USA with the potential for more to come. Despite such changes to growth forecasts, the Bank emphasised again that excess capacity will constrain future inflation, once various short-term factors ripple through higher headline inflation this summer. Many economists are rather more wary.
The precise details demonstrate short-term gain and long-term pain. Economic growth forecasts were revised up from 5.0% to 7.25% for 2021, albeit lowered from 7.25% to 5.0% for 2022. Although the UK economy is now expected to return to pre-covid levels of output by the end of 2021, the Bank’s longer-term concerns about the fundamentally weak state of the UK are demonstrated by a worrying figure – its forecast for GDP growth in 2023 is as low as 1.25%, no doubt reflecting inter alia the effects of Brexit, the pandemic, eventually tighter fiscal policy etc.
As a result of the change in view about the recovery in 2021, the peak in unemployment is expected to be as low as 5.4% this year versus a forecast peak of 7.8% made as recently as February. This is a useful reminder, if any is needed, about the practical difficulties of making accurate short-term forecasts in a fast-changing environment.
If growth was not a surprise, more of a surprise was the first sign of a shift in views on tapering amongst MPC members. Andy Haldane, who is stepping down after the June meeting, voted in favour of reducing the ceiling for asset purchases by the Bank. Although he was outvoted by his fellow members, the Bank is still making a subtle adjustment. It announced that for operational reasons it needed to reduce the amount of purchases it made each week from £4.4 billion to £3.4 billion. The rationale is that it has already carried out £70 billion of the £150 billion of asset purchases scheduled for the current year – hence the pace had to slow in coming months. Now just happened to be the right time. Of course, the Bank emphasised that this should not be seen as a shift in its monetary policy stance but as an operational decision, hence the initial responses in the sterling and gilts markets were modest.
Nevertheless, the combination of the economic upgrades, Haldane’s change of view, and the operational arguments about QE this year, all add fuel to the debate in the marketplace; the only question is when, not whether, the Bank starts to alter its stance more materially. The result can be seen in expectations of when the first interest rate move might be seen. On balance the fan chart of MPC members’ views is a rate increase in Q2 2023 while the markets see late 2022 as more likely. Consequently, the underlying trend in inflation in spring 2022 will be important.
Central banks, likes individual and institutional investors, are still trying to understand the extent of the fundamental changes in the world economy resulting from the pandemic. A clear message, however, is that the massive degree of monetary and fiscal stimulus seen in 2020-21 is having a major impact on economic activity and financial prices. Hence a debate has begun amongst policy makers – exemplified by this week’s Bank of England meeting, last week’s taper decision by the Bank of Canada, or Janet Yellen’s comments a few days ago that interest rates may need to rise as the US economy recovers – about the speed with which that stimulus needs to be withdrawn.
Andrew Milligan is an independent economist and investment consultant. This note should be considered as general commentary on economic and financial matters and should not be considered as financial advice in any form.
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