Bank of England: COVID-19 and furlough end could derail economy

Oscar Williams-Grut
·Senior City Correspondent, Yahoo Finance UK
·5 mins read
Bank of England Governor Andrew Bailey. Photo: PA
Bank of England Governor Andrew Bailey. Photo: PA

The Bank of England left policy unchanged on Thursday but warned the UK economy was in a precarious position as COVID-19 cases rise and the government’s furlough scheme draws to a close.

Policy setters kept interest rates at record low levels and maintained the Bank’s programme of bond buying at £745bn ($966.6bn), as had been widely expected.

The central bank said the UK economy was performing better than had been expected at its last meeting. However, rising COVID-19 cases, uncertainty around the end of the furlough scheme, and Brexit risks meant it was still unusually difficult to forecast and risks remain high.

“The outlook for the economy remains unusually uncertain,” the Monetary Policy Committee (MPC) said in a summary of its meeting.

The pound sank agains the euro and dollar in response to the policy statement.

READ MORE: UK inflation falls sharply as Eat Out to Help Out cuts average prices

The MPC said payments data showed consumer spending was back at January levels, recovering faster than the central bank had expected. Business investment remains low, however.

“Recent domestic economic data have been a little stronger than the Committee expected at the time of the August Report, although, given the risks, it is unclear how informative they are about how the economy will perform further out,” the MPC said.

The Bank of England upgraded its forecast for third quarter GDP to 7% below its pre-pandemic peak. The most recent data from the Office for National Statistics showed UK GDP remained around 12% below pre-pandemic levels in July.

Faced with this mixed picture, the nine-person MPC voted unanimously to keep the UK’s headline interest rate at 0.1%. The committee also voted to maintain the Bank’s asset purchase facility — a programme of bond buying often referred to as quantitative easing — at £745bn. Economists had widely forecast no change on either measure.

READ MORE: The UK economy's rebound lost momentum in July

However, the MPC signalled it would take action if needed, with risks to the UK economy continuing to mount.

“The recent increases in COVID-19 cases in some parts of the world, including the United Kingdom, have the potential to weigh further on economic activity, albeit probably on a lesser scale than seen earlier in the year,” the committee said.

“As in the August Report, there remains a risk of a more persistent period of elevated unemployment than in the central projection.”

In detailed minutes of the committee meeting, the MPC said there was “considerable uncertainty... about the prospects for employment” after the government’s furlough scheme ends next month.

The MPC said the outlook for the UK economy was dependant on “the nature of, and transition to” post-Brexit trading arrangements between the EU and UK.

The pound had been trading flat against the euro and dollar ahead of the announcement but fell sharply shortly after. Sterling was down 0.5% against the dollar (GBPUSD=X) and 0.4% against the euro (GBPEUR=X).

The pound sank against the dollar in the wake of the statement. Graph: Yahoo Finance UK
The pound sank against the dollar in the wake of the statement. Graph: Yahoo Finance UK

Vivek Paul, UK chief investment strategist at the BlackRock Investment Institute, said the Bank of England was “right” to strike “a cautious tone.”

“There are clouds on the horizon,” he said.

Pressure is growing on the Bank of England to inject further stimulus into the UK economy, with unemployment rising, growth slowing and inflation well below the Bank’s 2% target. The end of the government’s furlough scheme next month risks exacerbating all these problems.

Economists expect the bank to extend its asset purchases programme by £100bn at November’s meeting, with some speculating that interest rates could be cut further.

“All policy options remain on the table — we'd be surprised if we reach the end of the year without further QE and, even, another rate cut,” said Melissa Davies, chief economist at Redburn.

Policy makers have repeatedly hinted at the possibility of taking interest rates negative for the first time in British history. Governor Andrew Bailey said earlier this month negative rates were “in the box of tools” but said the Bank had “no plans to use it imminently.”

READ MORE: Bank of England governor hints at negative interest rates

“The minutes show a negative interest rate is still under discussion, which would help to get sterling down and keep government borrowing costs low,” Davies said.

The Monetary Policy Committee said it would “continue to monitor the situation closely and stands ready to adjust monetary policy accordingly,” repeating word-for-word language used in its August statement.

In March, the Bank of England cut the UK interest rate twice as the COVID-19 pandemic first struck. The cuts took the interest rate to its current record low level. At the same time, the central bank increased its bond buying activities to £645bn in a bid to support the UK economy and added a further £100bn to the asset purchase facility in June.

The MPC said at its August meeting that the UK economy was likely to contract by 9.5% this year, which would be the worst annual performance in a century.

Thursday’s policy announcement announcement came hours after the US Federal Reserve said it would likely keep interest rates near zero until 2023 in an attempt to underpin the economic recovery from the COVID-19 crisis.