Bank Of England Monetary Policy Report November 2020

11th November 2020

Monetary policy at the Bank of England

The objectives of monetary policy

The Bank's Monetary Policy Committee (MPC) sets monetary policy to keep inflation low and stable, which supports growth and jobs. Subject to maintaining price stability, the MPC is also required to support the Government's economic policy.

The Government has set the MPC a target for the 12-month increase in the Consumer Prices Index of 2%.

The 2% inflation target is symmetric and applies at all times. The MPC's remit recognises, however, that the actual inflation rate will depart from its target as a result of shocks and disturbances, and that attempts to keep inflation at target in these circumstances may cause undesirable volatility in output. In exceptional circumstances, the appropriate horizon for returning inflation to target can vary. The MPC will communicate how and when it intends to return inflation to the target.

The instruments of monetary policy

The MPC currently uses two main monetary policy tools. First, we set the interest rate that banks and building societies earn on deposits, or ‘reserves', placed with the Bank of England — this is Bank Rate. Second, we can buy government and corporate bonds, financed by the issuance of central bank reserves — this is asset purchases or quantitative easing.

The Monetary Policy Report

The MPC is committed to clear, transparent communication. The Monetary Policy Report (MPR) is a key part of that. It allows the MPC to share its thinking and explain the reasons for its decisions.

The Report is produced quarterly by Bank staff under the guidance of the members of the MPC.

Monetary Policy Summary

The Bank of England's Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. In that context, its challenge at present is to respond to the economic and financial impact of the Covid pandemic. At its meeting ending on 4 November 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted unanimously for the Bank of England to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £20 billion. The Committee voted unanimously for the Bank of England to continue with the existing programme of £100 billion of UK government bond purchases, financed by the issuance

of central bank reserves, and also for the Bank of England to increase the target stock of purchased UK government bonds by an additional £150 billion, financed by the issuance of central bank reserves, to take the total stock of government bond purchases to £875 billion.

Since the Committee's previous meeting, there has been a rapid rise in rates of Covid infection. The UK Government and devolved administrations have responded by increasing the severity of Covid restrictions. All restrictions announced up to and including 31 October have been reflected in the Committee's judgements.

There are signs that consumer spending has softened across a range of high-frequency indicators, while investment intentions have remained weak. The Committee's latest projections for activity and inflation are set out in the accompanying November 2020 Monetary Policy Report. These assume that developments related to Covid will weigh on near-term spending to a greater extent than projected in the August 2020 Report, leading to a decline in GDP in 2020 Q4.

Household spending and GDP are expected to pick up in 2021 Q1, as restrictions loosen. The level of activity in the first quarter is expected to remain materially lower than in 2019 Q4. UK trade and GDP are also likely to be affected during an initial period of adjustment, over the first half of next year, as the United Kingdom leaves the Single Market and Customs Union on 1 January and is assumed to move immediately to a free trade agreement with the European Union.

Over the remainder of the forecast period, GDP is projected to recover further as the direct impact of Covid on the economy is assumed to wane. Activity is also supported by the substantial fiscal policies already announced and accommodative monetary policy. The recovery takes time, however, and the risks around the GDP projection are judged to be skewed to the downside.

The fall in activity over 2020 has reflected a decline in both demand and supply. Overall, there is judged to be a material amount of spare capacity in the economy. The LFS unemployment rate rose to 4.5% in the three months to August, but it is likely that labour market slack has increased by more than implied by this measure. The extended Coronavirus Job Retention Scheme and new Job Support Scheme will mitigate significantly the impact of weaker economic activity on the labour market. The unemployment rate is expected to peak at around 7¾% in 2021 Q2.

Beyond that point, spare capacity is expected to be eroded as activity picks up, and a small degree of excess demand emerges over the second half of the forecast period. Twelve-month CPI inflation increased to 0.5% in September, but remained well below the MPC's 2% target, largely reflecting the direct and indirect effects of Covid on the economy. These include the temporary impact of lower energy prices and the reduction in VAT, as well as some downward pressure from spare capacity. CPI inflation is expected to remain at, or just above, ½% during most of the winter, before rising quite sharply towards the target as the effects of lower energy prices and VAT dissipate. In the central projection, conditioned on prevailing asset prices, inflation is projected to be 2% in two years' time.

The outlook for the economy remains unusually uncertain. It depends on the evolution of the pandemic and measures taken to protect public health, as well as the nature of, and transition to, the new trading arrangements between the European Union and the United Kingdom. It also depends on the responses of households, businesses and financial markets to these developments.

At this meeting, the MPC judges that a further easing of monetary policy is warranted. The Committee agreed to increase the target stock of purchased UK government bonds by an additional £150 billion in order to meet the inflation target in the medium term, taking the total stock of government bond purchases to £875 billion. The Committee will keep the asset purchase programme under review.

The MPC will continue to monitor the situation closely. If the outlook for inflation weakens, the Committee stands ready to take whatever additional action is necessary to achieve its remit. The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.

The economic outlook

Covid-19 and the actions to contain it have continued to have a dramatic and rapidly changing impact on the UK and countries around the world. Global activity fell sharply during the first half of 2020, reflecting the impact of the pandemic and the social distancing needed to contain its spread. As Covid cases fell, global activity recovered materially in Q3 from low levels. Recently, however, cases have risen again in many countries.

The outlook remains unusually uncertain. It will depend on the evolution of the pandemic and measures taken to protect public health around the world, as well as the nature of, and transition to, the new trading arrangements between the European Union and the financial markets to these developments.

The Monetary Policy Committee's (MPC's) projections assume that developments related to Covid will weigh on spending in the near term, although to a lesser extent than earlier in the year. UK activity in the first half of 2021 is also judged likely to be affected by lower trade as firms adjust to the UK and EU's new trading relationship. Over the forecast period, GDP is projected to recover as the direct impact of Covid-19 on the economy is assumed to wane. Activity is also supported by substantial fiscal and monetary policy actions. The recovery takes time, however, and the risks around the projection are judged to be skewed to the downside.

The fall in activity over 2020 has reflected a decline in both demand and supply. Overall, there is judged to be a material amount of spare capacity in the economy. Spare capacity is eroded as activity picks up and a small degree of excess demand is projected to emerge over the second half of the forecast period. CPI inflation is below the MPC’s 2% target, largely reflecting the direct and indirect effects of Covid-19 on the economy. These include the temporary impact of lower energy prices and the cut in VAT, as well as some downward pressure from spare capacity. As these effects wane, inflation rises. In the central projection, inflation is projected to be 2% in two years’ time.

To read the full report go HERE 49 pages