Ebury: Bank of England discusses negative rates, talks up Brexit risk

Ebury: Bank of England discusses negative rates, talks up Brexit risk

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Sterling fell by over half a percent versus its major peers on Thursday after the Bank of England left the door ajar to the possibility of negative UK interest rates.

Going into Thursday afternoon’s meeting, we noted that we thought the vote on the BoE’s quantitative easing programme would likely be the main driver for currency markets. The vote itself was mildly hawkish, with policymakers voting unanimously in favour of no change. There had been some speculation that one or two of the more dovish members of the committee could vote for an increase in asset purchases this month, namely messrs Saunders and Haskel. That being said, the 9-0 outcome was more-or-less expected and priced in by the market.

Undoubtedly the main talking point was the bank’s comments on negative interest rates. The minutes of the meeting noted that the MPC had discussed the use of negative rates and had been briefed on how such a policy ‘could be implemented effectively, should the outlook for inflation and output warrant it’. This is a bit of a departure from comments from the central bank prior to this month, in which it has noted that sub-zero rates were merely part of the ‘toolbox’ of measures that it could utilise. The bank noted that it would ‘continue to monitor the situation closely and stands ready to adjust monetary policy accordingly to meet its remit’.

This shift in the bank’s rhetoric towards negative rates overshadowed the vote on QE and was behind much of the initial move lower in the pound this afternoon (Figure 1).

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As we thought that it might, the bank also talked up the growing downside risks facing the UK economy, notably Brexit. The GDP forecast for Q3 was actually revised upwards, in light of recent stronger-than-expected domestic economic data. The MPC did, however, note that the outlook was ‘unusually uncertain’, explicitly mentioning Brexit, the recent increase in COVID-19 cases in the UK and the end of the government’s furlough scheme. According to the minutes, the bank’s most recent forecasts were contingent on an orderly move to a comprehensive free trade agreement by 1st January. This may be slightly optimistic, so we wouldn’t be surprised to see a downward revision to these forecasts in the coming months should Brexit not pan out as the bank anticipates.

We think that the wording of the BoE’s communications leaves open the possibility that the bank could ease policy again during its November meeting - when the next set of economic projections will be released. While the move to a negative interest rate policy (NIRP) is one such option, we think that it remains highly unlikely in 2020, although a 10 basis point cut to zero is a possibility. We remain of the view that the more likely move would be for the bank to ramp up its quantitative easing programme by another £50 billion in November, taking the total amount of purchases up to £795 billion. This would become increasingly likely in the coming weeks should the aforementioned downside risks begin impacting the UK’s so far resilient economic recovery.