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Bank of England: Cautious optimism reduces need for negative rates this year

The rapid vaccine rollout and the corresponding likelihood of a spring recovery has taken the pressure off the Bank of England to offer further stimulus. Policymakers will be careful not to shut the door on negative rates, but we don’t expect further rate cuts this cycle

The brighter outlook has taken the pressure off the Bank

The Bank of England is poised to unveil its latest decision this Thursday, and it’s now widely expected that policymakers will shy away from taking the plunge into negative interest rates this month. In fact, we think it’s unlikely they will do so at all in this cycle.

The outlook is brighter, and we expect the Bank’s new forecasts to continue to signal a full economic recovery around the turn of the year (albeit with some inevitable downgrades to growth this quarter). We are a little more cautious – we expect the combination of higher unemployment and ongoing disruption related to Brexit to prevent a full return to pre-virus levels for at least another 18 months.

But the conclusion is the same – with the vaccine rollout going well, and cases now falling rapidly, there is a good chance that the economy will record a rapid bounce in activity through the middle of the year. That in turn reduces the pressure to inject additional stimulus.

The BoE’s November forecasts assumed more-or-less a full recovery this year

Negative rates unlikely this cycle, but don’t expect the BoE to close the door on them

Of course, there are plenty of uncertainties in the outlook – not least how the new Covid-19 strains will affect the current batch of vaccines and therefore the need for future restrictions. But even so, what’s become increasingly evident from MPC commentary over recent weeks is that the willingness to enact negative rates is mixed.

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Some ‘external’ committee members, most notably Silvana Tenreyro, have signalled it is a move they are willing to make – though we suspect there won’t be any dissent this week. But the overall majority, including Governor Andrew Bailey, have played up some of the challenges.

On that note, we will get an update this week on the review that’s been carried out with the banking sector to see how negative rates might play out in practice. We suspect the general conclusion is likely to be that there are challenges, but that the sector could probably cope.

We don’t expect negative rates in this cycle

What’s less clear is how far the committee will go in passing judgement on how these findings affect the policy outlook. In theory, the findings are coming from the Prudential Regulation Authority (PRA), so it is entirely possible that the MPC passes no further judgement at this stage. However the findings could prompt the MPC to formally reduce its estimate for the ‘effective lower bound’ this week – which is a fancy way of signalling they are prepared to take rates below zero.

Either way, the key message is likely to be one of cautious optimism. We don’t expect negative rates in this cycle, though we could at some point see a step in this direction if the Bank decides to offer a negative rate on its Term-Funding Scheme, a policy designed to incentivise lending to SMEs.

If the outlook goes as planned, we also don’t foresee a further extension in the Bank’s QE programme beyond this year.

GBP rates: one last hurrah for negative Sonia forwards

The BoE meets at a time of benign market developments, with an improving economic outlook but still significant discount for negative rates. Something has to give. As we explained above, we do not see a strong case for taking the Bank rate below zero, but the conclusion to the PRA’s review on negative rates, and possible dovish dissent at this meeting, could be the cause of greater confidence in negative rates in the near term.

Some of the easing benefit of negative rates has been achieved already

We think this would be misguided. As the outlook improves, the case for negative rates will weaken. In a sense, some of the easing benefit of negative rate expectations has been achieved already with 1Y1Y Sonia swaps staying below zero since June last year. After a possible dovish reaction on Thursday, we expect this rate to move back above zero, and eventually above Sonia fixings (currently around 0.05%).

Sonia 1Y1Y to cross above zero, but curve flattening potential limited

In the grand scheme of things, this would be a fairly mild re-adjustment, and not something that threatens to invert dynamics at the long end of the curve. A more significant force in the pricing of longer rates is the impending recovery, and eventual tightening of policy.

As Bailey has stated, the BoE might start balance sheet reduction (quantitative tightening) before or during its rate hikes. This normalisation at both ends of the curve implies the flattening potential could be more limited than in the previous (shallow) hiking cycle in 2017-18.

Source: ThinkIng

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Sterling dips below $1.30, tough Brexit negotiations eyed

Sterling sank on Tuesday, dipping against a broadly stronger dollar as investors kept an eye on ongoing Brexit negotiations for fresh drivers for a currency that has hovered below the $1.30 mark since September.

Recent reports have shown that the European Union wants more concessions from Britain before entering a last, intense phase of negotiations on future relations following the United Kingdom’s departure from the EU.

The two chief negotiators, the EU’s Michel Barnier and Britain’s David Frost, say they are inching towards a deal, though they have underscored that important gaps remain on fishing, level playing field issues and governance.

British Prime Minister Boris Johnson had set a deadline of the Oct. 15 EU summit for agreeing a trade deal and Frost is in Brussels for intensified talks.

With no fresh news coming out of the negotiations, sterling was trading in tight ranges. By 1521 GMT, the pound was 0.6% lower to the dollar at $1.2983.

The pound has been only minimally affected this week by labour market data, the Bank of England further weighing the possibility of negative interest rates, and renewed social restrictions in the UK to combat a fresh wave of COVID-19 infections, despite the implications of these factors for Britain’s economy.

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On Tuesday, Housing Secretary Robert Jenrick said the British government may have to impose tougher restrictions than it currently has if the second spike of the novel coronavirus accelerates in high risk areas.

Johnson introduced a new tiered system of restrictions for England on Monday, with Liverpool and the surrounding Merseyside area placed in the highest level, with pubs shut, to curb an acceleration in COVID-19 cases.

“The UK government announced stricter containment measures in some areas of the country and top health officials are already suggesting more will likely be needed,” ING strategists said in a note to clients.

“This is not good news for the battered UK economy but with Brexit negotiations at a critical phase, hardly anything else looks likely to impact the pound (the lack of reaction to labour data and comments about negative interest rates being a case in point).”

The Bank of England asked banks on Monday how ready they are for zero or negative interest rates. BoE policymaker Jonathan Haskel said the central bank had an “absolutely open mind” about the possibility of sub-zero rates as part of its support for Britain’s economy during the coronavirus crisis.

Britain’s unemployment rate rose by more than expected to 4.5% in the three months to August, its highest in more than three years, even before the end of the government’s broad coronavirus job protection plan.

Economists polled by Reuters had expected the jobless rate to rise more slowly, to 4.3% from 4.1% in the three months to July.

Sterling traded in tight ranges against the euro on Tuesday, last flat at 90.40 pence per euro.

“As we still see no major breakthrough in the Brexit negotiations this week, we think euro-sterling will continue to be trapped in the 0.90-0.92 range,” said Kristoffer Kjær Lomholt, Chief Analyst at Danske Bank.

Reporting by Ritvik Carvalho

Source: UK Reuters

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Will the BoE inject more stimulus into the UK economy?

The BoE is preparing to announce its latest interest rate decision tomorrow, as it closely monitors the UK economy’s rebound from the record 20.4 per cent contraction in the second quarter.

Since then, there have been many positive signs. The economy grew by a huge 8.7 per cent in June and another 6.6 per cent in July. More recently, Britons were enticed to the high street by August’s Eat Out to Help Out scheme.

But there are challenges on the horizon. First and foremost is the worrying rise in coronavirus cases and new restrictions. Inflation also fell to 0.2 per cent in August, well below the Bank’s two per cent target.

That’s a lot for the Bank of England to consider. And analysts are united in saying the BoE will leave interest rates on hold at 0.1 per cent and its bond-buying target at £745bn.

They say that the Bank is more likely to increase stimulus in November after seeing how the economy and inflation fare.

Further stimulus will wait until November

“Even if the Bank felt more loosening was ultimately going to be required, we see little benefit to the Bank announcing it now,” said George Buckley, chief UK economist at Nomura in a note to clients.

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Buckley pointed out that the Bank’s current bond-buying programme is scheduled to be completed around December. So, he said, “why not wait until the November meeting when the MPC [monetary policy committee] will have the luxury of analysing another seven weeks of economic data?”

Howard Archer, chief economic adviser to the EY Item Club, agreed. “There seems little need for further MPC stimulus action – for the time being at least,” he said.

“It currently looks very possible that GDP growth in the third quarter could be around 15 per cent following the record 20.4 per cent contraction in the second quarter.”

Analysts say that if the Bank decides to act in November, as many predict it will, it is likely to increase bond-buying rather than cut interest rates further.

Bank could take a ‘dovish turn’

In August, the Bank predicted economic growth would be better than expected in the near term. Yet it was more pessimistic longer-term, saying the economy would regain its pre-pandemic size at the end of 2021.

Its forecasts were more upbeat than most, however. Jacqui Douglas, chief European macro strategist at TD Securities, said in a note that the Bank therefore could well take a “dovish turn” tomorrow. She predicted there will be “more focus on the downside risks to growth going forward”.

Although the Bank is not publishing any new forecasts, it has tended to enlarge on its decisions in a statement.

Douglas said: “The downside risks to the outlook have come into sharper focus.” She cited “an upcoming wave of job losses to the challenge of controlling Covid outbreaks to Brexit negotiations”.

UK inflation also dropped to 0.2 per cent in August, dragged down by the Eat Out to Help Out discount meal scheme. But that was better than the Bank had expected.

Nomura’s Buckley said that there is a chance Jonathan Haskel or Michael Saunders could vote for more bond-buying during this meeting. They have traditionally been more dovish MPC members, and Saunders recently said it is “likely” more easing will be required.

What has the Bank of England done so far?

The Bank slashed interest rates to a record low of 0.1 per cent from 0.75 per cent in two special meetings in March.

It also beefed up its quantitative easing programme – through which it creates money and buys bonds to keep borrowing costs low – to £645bn in March. The Bank then increased its bond-buying target to £745bn in June.

The MPC has also put negative interest rates in its “toolbox” of possible measures for the first time.

However, at its August meeting it did not sound too keen to actually get them out and use them. It said that “negative policy rates at this time could be less effective as a tool to stimulate the economy”. The Bank added that “the MPC has other instruments available”.

By Harry Robertson

Source: City AM