MNI INSIGHT: BOE To Stress Divergent Scenarios In August MPR

--Covid-19 Uncertainties A Barrier To Credible Single Route Forecast

By David Robinson

     LONDON (MNI) - The Bank of England could buck a trend for central banks to

return to publishing central forecasts and instead use its August Monetary

Policy Report to unveil sharply divergent scenarios for the economy depending on

how the Covid-19 shock unfolds.

     The UK government is gradually lifting pandemic lockdown restrictions in

response to Covid and plans to end its big-ticket job support scheme in October.

With uncertainty over a potential second wave of infections, policymakers are

finding that their usual focus on a modal, or most likely, path is of little

use, given the dramatically different paths that events could take.

     The Office for Budget Responsibility has already blazed a trail, producing

three separate scenarios, central, upside and downside ones, reflecting how the

pandemic and associated economic scarring might play out. BOE Chief Economist

Andy Haldane told the Treasury Select Committee on Monday he certainly sees

sense in such an approach, adding that the path ahead of the economy will be

shaped not only by the course of the virus, but by how business and consumer

spending hold up in the face of uncertainty and changes in policy.

     --CHALLENGES

     If the BOE's Monetary Policy Committee, which in its May Monetary Policy

Report for the first time constructed a single illustrative economic scenario

instead of a central forecast for growth and inflation, did decide follow the

OBR's lead Aug. 6, it would face tricky challenges over how to factor in fiscal

and monetary policy setting.

     The MPC's primary interest rate forecasts have been based on market

expectations extracted from the overnight indexed swap curve. This, however,

represents a weighted average of a range of possible outcomes and using it to

underpin a single scenario would, at least in theory, be incongruous. In

practice, though, with interest rate curves so flat the MPC may be able to get

away with using the OIS curve, as the OBR did, for its various scenarios as Bank

Rate in reality may stay close to zero in every case.

     Assuming unchanged asset purchases could also create complications as in

the rosiest of scenarios there may be a case to factor in some unwinding of

asset purchases, with BOE Governor Andrew Bailey arguing for quantitative

tightening (QT) before rate hikes.

     The MPC also faces a headache over fiscal policy, with the Bank's

longstanding approach being that it assumes government policy will be constant.

As the Treasury's job support schemes are currently set to be axed in October,

such an approach in a pessimistic scenario with a second lockdown would produce

alarming outcomes.

     --RATE PATH

     But producing scenarios are not the only challenge facing the MPC in its

Monetary Policy Report.

     OIS curves also appear to have been pricing in a chance that the MPC will

end up cutting Bank Rate, currently at 0.1%, below zero. The next MPR might

normally provide a natural occasion for it to announce the result of its review

as to whether negative rates are plausible, but the Bank will also bear in mind

that any such announcement could in itself dampen animal spirits.

     Meanwhile, with market rate expectations dipping below zero, the MPC has

already generated extra stimulus by simply not ruling out negative rates.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

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