The Bank of England (BoE) remained on hold (0.75%) albeit suggesting that it has moved a step closer to cut interest rates
The BoE maintained its policy rate at 0.75% and the QE target at £435bn, as expected. However, in a dovish surprise, two out of nine members of the Monetary Policy Committee favored a rate cut by 25 bps. Furthermore, in its post meeting statement, the BoE dropped its modest tightening bias that “increases in interest rates, at a gradual pace and to a limited extent, would be appropriate in the medium term”.
Instead, a more balanced forward guidance was introduced, depending mainly on the evolution of global economic growth and Brexit developments. The BoE cited that if global growth undershoots its expectations and/or Brexit uncertainty remains, monetary policy will need to loosen. On the other hand, a modest tightening “at a gradual pace and to a limited extent” may be warranted. In our view, the BoE will likely keep its policy rate unchanged at 0.75%, but we expect a rate cut in the event of a hung parliament post the December elections and a comprehensive easing policy package assuming a “no-deal” Brexit.
Regarding global GDP, real growth is assumed to revert towards its potential in the medium term (+3.5% in 2021 and 2022), versus 3% in both 2019 and 2020. The aforementioned projections assume that no further trade barriers will be introduced (i.e. US/China and/or US/EU) but also that no existing tariffs are rolled back.
Regarding Brexit, the BoE assumes an orderly transition to “a deep free trade agreement” between the UK and the EU, in line with the Political Declaration accompanying the recently agreed Withdrawal Agreement (its ratification is pending in lieu of the forthcoming General Elections due on December 12). Specifically, the BoE assumes, inter alia, that: i) trade in goods will be tariff free, but with customs checks being introduced; ii) part of the trade in services, especially financial services, will be subject to barriers; and iii) regulatory trade barriers related mostly to product standards will increase gradually.
The BoE anticipates flat UK real GDP growth in the short term and a considerable recovery in the long-end of its forecasting period (up to 2022), albeit acknowledging that the balance of risks surrounding its forecasts are skewed to the downside. A material fiscal easing is factored in, according to the outgoing government’s tax and spending plans announced in September, which could boost real GDP by 0.4% cumulatively by 2022. Recall that in the past week, both the Labour and Conservative parties set out their early fiscal plans, with both parties suggesting a significant increase in public investment through increased borrowing (Moody's cut its outlook for UK Government debt to negative with an Aa2 rating on Friday).
UK real GDP is projected to increase by 1.25% (2019), 1.25% (2020), 1.75% (2021) and 2% (2022) broadly in line with consensus estimates. The respective projections for CPI inflation stand at 1.5% (2019), 1.5% (2020), 2% for 2021 and 2.25% for 2022, implying only a moderate overshooting of inflation versus its target of 2%. Note that GDP and CPI forecasts were conditioned on a forward market path for SONIA (Sterling Over Night Index Average) rates (cut-off date October 30th) that indicates a cut in policy rates by 25 bps to 0.50% by Q4:2020.