After a dovish performance from the US Federal Reserve yesterday, investors have been waiting to see what the Bank of England thinks about the UK economy. Economists were expecting the bank to signal that it will raise interest rates, something that would help to extend the current Pound Sterling rally. However, the bank has disappointed by announcing that it will not raise interest rates until inflation is under control and has risen considerably.
The Pound has strengthened in 2021 after the bank confirmed that it won’t take interest rates into negative territory and the assumption now was for the bank to raise them and support the pound.
Bank remains cautious
However, while economic recovery and the vaccination programme have offered a positive outlook, the bank chose to maintain the current pace of quantitative easing (£4.4bn weekly) and reach its inflation target. The bank said that "The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress has been made in eliminating spare capacity and achieving the 2.0% inflation target.” After the employment fell during the pandemic the Bank expects it to recover so that rising wages start pushing inflation higher. The bank’s decision reflects a more cautious stance as it prefers to wait and see how things develop and whether inflation rises above 2.0% as employment recovers closer to pre-pandemic levels.
The pound fell as investors and traders were expecting a more hawkish tone from the bank.
The Bank noted that recovery from April 2022 onwards will slow down due to the March Budget which will create a medium-term fiscal tightening. They stated that there is little hope that CPI inflation will rise above the target at the end of this year. According to Samuel Tombs, Chief U.K. Economist at Pantheon Macroeconomics: "The MPC chose not to push back against the recent rise in rate expectations and gilt yields. This was never likely, given that the first rate hike isn’t fully priced-in by markets until Q1 2023; the Committee can’t make credible commitments that extend so far into the future.” Tombs added that interest rates will be raised soon as long as the markets recover. More generally, though, the Bank of England appeared to be less gloomy about unemployment and that a more resilient than expected economy will help improve the employment landscape.
BoE: signs of economic recovery
While the Bank of England’s MPC voted 9-0 to leave interest rates and QE unchanged, there are several signs that point that the economy is improving. Since the MPC’s previous meeting, the near-term economic activity had been positive. The issue now is whether companies and households will increase their spending once the lockdown ends or whether they’ll be cautious. Minutes of the meeting said that Rishi Sunak’s decision to extend the furlough until the end of September has also helped to change the outlook for the unemployment rate.
Indeed, Hugh Gimber, global market strategist at J.P. Morgan Asset Management, highlighted that the economic outlook has improved as “the Monetary Policy Committee is feeling a little more comfortable about the prospects for the economy than at its last meeting six weeks ago. The latest budget confirmed that government lifelines for the labour market will continue, the vaccine rollout is progressing at pace, and a gargantuan stimulus package across the Atlantic should have positive spillover effects across the globe. Against this backdrop, the UK economy is poised for a strong rebound this year.”
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