The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.
In that context, its challenge at present is to respond to the economic and financial impact of the Covid-19 pandemic.
At its meeting ending on 4 August 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted unanimously for the Bank of England to continue with its existing programmes of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, maintaining the target for the total stock of these purchases at £745 billion.
The Committee’s projections for activity and inflation are set out in the accompanying August Monetary Policy Report.
Although recent developments suggest a less weak starting point for the Committee’s latest projections, it is unclear how informative they are about how the economy will perform further out.
The outlook for the UK and global economies remains unusually uncertain. It will depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors. The MPC’s projections assume that the direct impact of Covid-19 on the economy dissipates gradually over the forecast period.
Given the inherent uncertainties regarding the evolution of the pandemic, the MPC’s medium-term projections are a less informative guide than usual.
Global activity has strengthened over recent months, although it generally remains below its level in 2019 Q4. Covid-19 has continued to spread rapidly within a number of emerging market economies, however, and there has been a renewed rise in cases in many advanced economies.
UK GDP is expected to have been over 20% lower in 2020 Q2 than in 2019 Q4. But higher-frequency indicators imply that spending has recovered significantly since the trough in activity in April. Payments data suggest that household consumption in July was less than 10% below its level at the start of the year.
Housing market activity appears to have returned to close to normal levels, despite signs of a tightening in credit supply for some households. There is less evidence available on business spending, but surveys suggest that business investment is likely to have fallen markedly in Q2 and investment intentions remain very weak.
Employment appears to have fallen since the Covid-19 outbreak, although this has been very significantly mitigated by the extensive take-up of support from temporary government schemes. Surveys indicate that many workers have already returned to work from furlough, but considerable uncertainty remains about the prospects for employment after those support schemes unwind.
In the near term, the unemployment rate is projected to rise materially, to around 7½% by the end of the year, consistent with a material degree of spare capacity.
In the MPC’s central projection, GDP continues to recover beyond the near term, as social distancing eases and consumer spending picks up further. Business investment also recovers, but somewhat more slowly. Unemployment declines gradually from the beginning of 2021 onwards. Activity is supported by the substantial fiscal and monetary policy actions in place.
Nonetheless, the recovery in demand takes time as health concerns drag on activity. GDP is not projected to exceed its level in 2019 Q4 until the end of 2021, in part reflecting persistently weaker supply capacity. Given the scale of the movements in output, as well as the inherent uncertainty over the factors determining the outlook, the evolution of the balance between demand and supply is hard to assess.
The MPC’s central projection implies that a margin of spare capacity is likely to remain until the end of next year. The risks to the outlook for GDP are judged to be skewed to the downside.
Twelve-month CPI inflation increased to 0.6% in June from 0.5% in May. CPI inflation is expected to fall further below the 2% target and average around ¼% in the latter part of the year, largely reflecting the direct and indirect effects of Covid-19.
These include the impact of energy prices and the temporary cut in VAT for hospitality, holiday accommodation and attractions. As these effects unwind, inflation rises, supported by a gradual strengthening of domestic price pressures as spare capacity diminishes.
In the MPC’s central projection, conditioned on prevailing market yields, CPI inflation is expected to be around 2% in two years’ time.
The Committee will continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit.
The MPC will keep under review the range of actions that could be taken to deliver its objectives. The Committee does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.
Commenting on the Bank of England holding interest rates at 0.1% and suggesting that the economy faces a less severe downturn but slower recovery from the coronavirus pandemic, Douglas Grant, Director of Conister Finance & Leasing Limited, said:
“Today’s announcement further highlights the long term nature of our country’s economic recovery. In the short to medium term, we are facing a significant double dip recession that could last well into late 2021 and the economy will be hurt by both SMEs closing and mass redundancies for a significant part of the workforce.”
“Many clearing banks are working tirelessly to process emergency loan applications but with pressures piling up, a lot of SMEs will become unsustainable. We are seeing a resurgence in ‘zombie companies’ where businesses are servicing debt from remaining cash flows with little or no capital for investment and according to The City UK, it is estimated that UK businesses may build up £100 billion of debt by next March which they would be unable to repay with 780,000 SMEs in danger of insolvency.”
“SMEs are not just the lifeblood of the economy, it is where innovation and creativity happens – their existence must be safeguarded. Alone, the more traditional clearing banks cannot alone keep the UK’s business sector alive during this perilous time.”
“Since the epidemic took hold, the UK Government has been quick to back sectors that are resilient to recessions and market volatility, providing financial security and protection through initiatives such as the bounce-back loans scheme.”
“It is imperative that SMEs have a tripartite level of sustainable support from Government, alternative and traditional lenders working together to identify and protect the more resilient sectors such as infrastructure, technology and renewables, ensuring their existence guaranteed.”
“This is where alternative lenders that understand the characteristics of specialist SMEs and with the flexibility they offer, empower their staff to make judgement calls on capital requirements often in the infancy stage of lending, can provide the additional support and natural lending progression alongside the larger clearing banks.”