The Bank of England (BoE) announced its Monetary Policy on Thursday, 5th August 2021. As expected, the BoE followed the footsteps of the Federal Reserve, which announced its monetary policy last week. As predicted by economists, the BoE kept the monetary policy unchanged much like the strategic path adopted by the Federal Reserve. The Monetary Policy Committee (MPC) led by Governor Andrew Bailey, retained the Bank’s main lending rate at 0.1% (the same rate maintained since March 2020). However, some unorthodox changes were announced in the form of hawkish cues concerning the Quantitative Easing (QE) program.
The BoE currently maintains the purchase of government bonds at £895 billion – equivalent to $1.25 trillion – yet many economists predicted that similar to Fed, the BoE would embark on an identical path to start winding up the program sooner rather than later. The expectations were further fuelled as the inflation forecasts were raised again for the second consecutive month to 4% by the fourth quarter of 2021. However, the committee voted 7-1 in favor of continuing the asset purchases – eyeing the total of £150 billion of bond purchases cumulated by the end of 2021. Despite the commitment to the QE program, the committee rendered a Fed-like imprint on the investors following the press conference – just rather perversely.
The Monetary Policy Report of the BoE suggested that much like the Fed, the UK’s central bank also views inflation as mere transitionary. The report stated: “Above-target inflation is expected to be transitory, as commodity prices stabilize, supply shortages ease and global demand rebalances,”. The statement put forward clearly implies that the surging hike in the consumer Price Index (CPI) is mainly associated with rising prices of goods and energy, fueled by Consumer sentiments that are expected to cool down in the following months. Thus, the MPC devised that it would not want to put: “undue weight on capacity pressures that are frictional in nature and likely to be temporary”. The statement is disparate of the perspective that many economists believed would influence the BoE in pulling the brakes on the QE program that has bloomed for a decade.
The MPC’s position, however, is supported by the economic data. UK’s economy, despite growing by 5% in the second quarter of 2021, is still 4% below the pre-pandemic level. The forecast was further pulled down to 3% for the third quarter. Despite that, the MPC cast an optimistic forecast of an annualized growth of 8.5% for 2021. However, the committee believed that with wage support ending in September and new infections threatening the return of the workforce, the growth would be further hampered if the BoE tightens the screws earlier. Nevertheless, the Bank would probably pull the strings on the interest rates gradually starting next year as the economy performs in full swing.
Unlike the US and Chinese economies – both surging above and beyond their pre-pandemic sizes – England’s economy is still clawing its way out of the pandemic. Now as the delta variant is emerging as a dominant strain, the economy is expected to be short by an estimated 2 million employees by the end of this year. This is a serious threat to the economy given the end of England’s furlough program fast approaching by the end of September. Unemployment is already peaking at 4.5% despite an upbeat wage increase of 3.5%. If the trend continues, exacerbated by new lockdown measures to curb the spread of delta variant, it would most likely cause a further surge in unemployment eventually dragging the economy into a spiral of stagflation.
Thus, the reasons clustered together justify BoE’s policy measures. The MPC, in stark contrast to expectations, lowered the threshold of a taper from a 1.5% base rate – set back in June 2018 – to 0.5%. Simply put, the Bank of England would not reinvest in maturing government securities once the base rate sustains at 0.5% (a significant recalibration from the 1.5% mark maintained for years). The move would most likely assuage the hawkish fractions in the Bank of England’s arsenal. However, if the historical bank rate progression is to be followed, the timeline dictates a 0.5% bank rate to strike by the third quarter of 2024 or even the first quarter of 2025; after hitting 0.2% in the third quarter of 2022 and 0.4% for the same period in 2023. This would be a contrast to the otherwise intact follow-up of the Fed’s strategy to taper its asset purchases sooner rather than later.
The MPC suggested, however, that the Bank would not resort to reduce the stockpile of government bonds until the base rate climbs up to 1%. Thus, the Bank is deliberate enough to maintain excess liquidity in the economy till at least 2025 to avoid the nightmarish deflationary pressures faced by the UK in the aftermath of the 2008 Financial Crisis. The diplomatic policy insinuates a doubt regarding the sensitivity of a fragile economy; not apparent of the consequences once-rising prices are not artificially sustained. However, given that the US has already achieved its pre-pandemic level of GDP while England trails in catching up, the policy is appropriate to be divergent from a contractionary agenda.
The Monetary Policy Committee has carefully drafted its strategy to target an accommodative monetary policy in face of a tightening fiscal policy. Despite that, the rate hike would most likely mirror the Fed’s timeline of early 2023. However, a decade-long QE program could not possibly be ceased in a few months, especially as the economy stabilizes from a pandemic. Now as the economy rebounds and England is likely to achieve its pre-pandemic level of output by the fourth quarter of 2021, it would be a sight to watch as the BoE balances its dovish policy in the face of a price-buoyant scenario. However, the current purview points to a belated shift of policy; inverse to the early-budding hawks in the echelons of the Federal Reserve.