MNI STATE OF PLAY: BOE Sees Boost To GDP, Moderate Inflation

The Bank of England will announce higher near-term growth forecasts after its meeting on Thursday and could slow its bond purchases, but any change in calculations of the proximity of monetary tightening may ride on whether it sees inflation around its target levels towards the end of its three-year horizon.

Bank staff have already acknowledged upward surprises from the recovery in global growth, the extension of fiscal support in the March 3 Budget and the speed of UK re-opening from Covid. The IMF's updated UK forecast 5.3% for 2021 compared to the BOE's expectation of 5.0% in its February Monetary Policy Report, a number which may now edge higher.

It would take an increase in inflation projections to bring forward expectations of tightening. In February, the BOE had assumed inflation would only reach 1.89% by the first quarter of 2024 if rates were left unchanged. Even incorporating what were then market assumptions of negative rates, inflation only peaked at 2.15% in Q3 2022 before falling back marginally below the 2% target to 1.98% in Q1 2024.

While the BOE may boost its short-term growth outlook, its medium-term projections may continue to show a return to the sluggish pre-pandemic trend rate of growth. The February MPR showed growth hitting 7.25% in 2022 before slumping back to 1.25% the following year.

The Bank may say that it will reduce the pace of its asset purchases, though only for operational reasons. In liquid markets, with a pre-announced target, it regards the rate of purchases as irrelevant to monetary policy, and its current GBP4.4 billion weekly buying is too rapid to be compatible with its stated goal of carrying on the current GBP150 billion round until the end of this year. Analysts, though, are divided over whether a reduction in the rate of purchases will come this week or not until as late as August.

TIGHTENING STRATEGY

The Bank is also reviewing its current pre-announced strategy for eventual tightening, as well as preparing a framework for how it might if needed in the future be able to cut rates below zero without causing problems for the financial system. The negative rates framework is due by August, and news on the tightening strategy review may not come until the same month, because tightening strategies depend on an assessment of the lower bound for interest rates, given that policy makers need to know how much they can ease in case the economy lapses back into weakness.

Under its current strategy, the BOE would only start to unwind asset purchases when Bank Rate, currently at 0.1%, reaches around 1.5%, a level which the Monetary Policy Committee feels gives ample scope for boosting the economy via rates cuts if necessary. This though, assumes the lower bound of interest rates is around zero, while those such as MPC member Silvana Tenreyro now argue that Bank Rate could potentially be cut to at least as low as -0.75% within a proper negative rates framework. That could mean that the BOE might only need to raise rates to 0.75% before it felt it had enough scope for future easing to be able to unwind asset purchases.

In order to mitigate the effect of any future cut in Bank Rate below zero on net interest margins, the BOE is likely to design a tiering system allowing banks to continue to earn interest on portions of their reserves deposited at the central bank, former senior BOE official David Aikman told MNI recently. The review will also have to produce an estimate of the effective lower bound, he said.