MNI INTERVIEW: BOE Policy To Regain Traction As Covid Ebbs

UK monetary policy will regain effectiveness in providing stimulus as mass Covid vaccinations and the ebbing of the pandemic restore normal economic interactions, the head of macroeconomic policy at think-tank The Resolution Foundation told MNI.

The enforced squeeze on supply and income loss in social spending sectors due to Covid, coupled with a surge in savings, have disarmed monetary policy, but this should regain traction as the economy emerges into a more typical downturn, James Smith said in an interview, noting that demand for monetary stimulus in the recovery phase will be strong.

"When you are in this lockdown phase the right policy is incomes-based fiscal policy so you provide that social insurance … It has flipped on its head how fiscal and monetary policy work together," Smith, a former senior Bank of England economist, said.

"Fiscal policy is now becoming a very reactive, high frequency changing policy and monetary policy is now basically on auto pilot throughout the whole of next year," he added.

ECONOMY 6% SMALLER

The near-term outlook has deteriorated markedly, with borrowing set to rise more strongly than anticipated and growth to come in much weaker as the country faces more lockdowns.

The Resolution Foundation's forecast is that the economy will be 6% smaller by Easter than the official fiscal forecaster, the Office for Budget Responsibility, predicted just last month. The OBR itself has said the accompanying month- and two-month extensions respectively of its main income support scheme, the Coronavirus Job Retention Scheme, and its loan guarantee schemes will alone add GBP7 billion to borrowing.

The Bank of England has sanctioned an extension of the asset purchase scheme through to the end of 2021 and is considering the viability of negative interest rates, with some Monetary Policy Committee members stressing that the emergence of a vaccine reinforces the case for policy to help bridge through to a full recovery.

VACCINE BOOST

While things are set to get worse before they start to recover one bright spot is that the surge in savings should a rapid increase spending by the better off who receive the vaccine, with the typically more asset-rich elderly first in line.

"Even if we did something like a million vaccines a week it would still take quite far into the year before we had all the vulnerable population vaccinated. So it will take a while but when you get to that point what you will see is people splurging to some degree, going on a more exotic holiday or visiting a more expensive restaurant," Smith said.

"Around the middle of the year you will get this splurge and that will have a strong boost to the economy but at the same time the Job Retention Scheme will have ended, unemployment will be higher, incomes will be hit. You will get something more like a standard demand-deficient recession and then what you will need from the Chancellor and continued from the Bank of England is support to drive that rapid recovery," Smith added.

The Resolution Foundation, like the OBR and the BOE, assumed in its forecasts that a trade deal with the EU would be struck and the case for further support needed to bolster demand after the economy starts to emerge from the Covid shock is not impacted by the deal news.