BoE Preview: Raising Stock To Sustain The Flow

• The prevailing state of the UK economy is unrecognisable relative to the BoE’s last monetary policy report in January. Substantial downgrades are unavoidable, but so is the uncertainty around it.
• Damaged balance sheets will prevent a full and rapid recovery, supporting ongoing stimulus. With little hope for imminent normalisation and serious downside risks from secondary shutdowns, I expect the BoE to sustain its asset purchase pace.
• A slower pace of purchase would be needed to avoid hitting the current target stock before August. As that is undesirable amid sustained heavy gilt issuance, I expect the BoE to announce a £55bn increase to £700bn, with little point waiting.

Updated BoE Projections Will be Significantly Revised

When the BoE published its Monetary Policy Report (MPR) on 30 January, Covid-19 was still a distant affliction that had no bearing on its forecast. Committee members appeared to treat it as potentially like SARS with no direct policy impact, and in fairness, my forecasts were in a similar state. Less than six weeks later, the BoE delivered its first emergency rate cut before moving to the lower bound and launching QE the following week. Precautionary distancing was destroying demand ahead of an unprecedented lockdown that has since smashed the economy.

Even now, there is little reliable data to put the shock in context. The early official readings, which I expect to be less bleak than the consensus, will likely be biased to understate the collapse. The BoE’s assessment of the depression will no doubt attract many headlines. However, it arguably lacks a significant edge here, while the differences in the short-term matter little. The level of persistent damage to demand relative to supply should have more bearing on the optimal policy outlook that the MPC attempts to set.

The depth of the depression will have a bearing on the recovery through the lasting damage it does to balance sheets. Government loans aid liquidity rather than solvency, and problems with the latter, especially in an environment of ongoing social distancing, mean many failures and job losses will be deferred until lockdown support starts to roll off. The gap between normalisation in business and fiscal support will influence how incomplete the recovery rate is, but the BoE will probably assume no errors here. It will also probably assume a gradual fading of restrictions and no secondary shutdown, as government policy is to avoid virus transmission getting bad enough again to justify it.

That assumption would be broadly consistent with the consensus, but the risk there is unavoidably skewed towards there being another lockdown. It’s not like we can go back in time and prevent the current one from occurring! Rather than treat this as part of the usual fanchart, though, the BoE seems set to acknowledge that this is not part of some single continuous distribution. An alternative scenario forecast should illustrate this gloomier and more dovish risk.

Alternative scenarios influence the optimal policy outlook as well as the central projections, and I expect that to help motivate an early increase in the target stock of asset purchases.

Size of QE Likely to be Increased on Thursday

The BoE does not have enough leeway within its current stock target to maintain the current purchase pace until the August MPR. Slowing weekly purchases from £13.5bn per week to £5bn from the June MPC meeting would stretch the programme sufficiently, whereas a £55bn increase in the target size is needed to maintain the pace (Chart 1). The MPC has tended to put more emphasis on the stock than the flow during previous QE rounds, but the two are linked and should respond to the economic need. If the BoE slows its purchases from June, the net issuance hitting the market will surge (Chart 2), and the increased gilt stock in private hands could have an undesirable tightening effect on financial conditions.

The BoE has room to keep things as they are until the June MPC meeting before deciding on whether to increase the stock or slow the flow from there. However, there is little point in waiting until then, so I expect the BoE to announce a £55bn increase to £700bn on 7 May.

Even if lockdown measures have mostly eased by then, the economy will be a long way from normalised and not in need of an immediate monetary tightening. If the lockdown ends faster so the economy is rebounding sooner and fiscal pressures are smaller, the BoE could still slow purchases and draw out the programme until November, or even terminate early in the unlikely extreme. A secondary stage of lockdowns would motivate far more purchases than currently planned anyway.

Delaying Any Increase Risks Another Emergency Policy Shift

Failure to increase the target stock on 7 May would risk the BoE having to make another emergency policy change if the lockdown cannot lift as it likely assumes in the central projection. It would also avoid market uncertainty ahead of a deferred extension announcement that might have some detrimental effects on financial conditions. Erring on the side of earlier and more aggressive action is the classic reaction function during easing cycles, and the BoE has embraced that so far. I expect it to keep doing so with the announcement on 7 May, rather than waiting until 18 June.

Note: This calculation focuses on natural holders of duration, so does not income redemptions or T-Bills

Phil Rush is the Founder and Chief Economist at Heteronomics, an independent macroeconomic research consultancy specialising in the UK economy. Prior to this, Phil spent 10 years on the sell-side, with his previous role being at Nomura as a Senior European Economist.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)