The Bank of England has tempered its previous optimism over the UK’s recovery from the coronavirus crisis, with new forecasts showing a faster initial rebound in GDP but a slower return to its pre-pandemic peak.
The Monetary Policy Committee left policy unchanged on Thursday, with interest rates on hold at 0.1 per cent, and its target for the total stock of asset purchases also steady at £745bn.
The committee said the initial hit from coronavirus lockdown measures had been less severe than it projected in May, although it still expected output to be more than 20 per cent lower in the second quarter of 2020 than in the final quarter of 2019.
A strong recovery in some areas of consumer spending is expected to drive a rapid rebound over the coming months, with GDP falling 9.5 per cent over the year as a whole, compared with the 14 per cent contraction the central bank had projected in May.
However, the BoE believes the recovery will slow dramatically after the third quarter of 2020, reflecting consumers’ continued concerns about health risks and fears over job security. Its central forecast shows GDP more than 5 per cent below its pre-pandemic peak at the end of 2020, and only regaining its pre-crisis level at the end of 2021.
The MPC stressed there were big downside risks to this forecast and said it would not tighten monetary policy without clear evidence “that significant progress is being made in eliminating spare capacity and achieving the 2 per cent inflation target sustainably”.
Andrew Bailey, the BoE governor, said this meant there would be no move to withdraw stimulus until the MPC was sure that unemployment was falling and inflation was set to rise above target. The BoE remained “ready to act” with fresh stimulus if the economic outlook worsened, he added.
Mr Bailey signalled the BoE was not contemplating any move to cut interest rates into negative territory in the short term. Negative rates “are part of our toolbox . . . but at the moment we don’t plan to use them,” he told reporters.
The bank’s central forecast shows consumer price inflation falling further below target in the near term, averaging about 0.25 per cent in the latter part of the year, and rising close to the MPC’s 2 per cent target in two years.
The BoE has assumed there will be continued concerns over infection risk and some restrictions on economic activity over the coming months, although it does not see a likelihood of a second national lockdown.
However, many economists said the bank’s predictions for a rapid rebound still appeared too optimistic.
“The V-shaped recovery that the BoE continues to project seems unlikely, to put it very mildly,” said Kallum Pickering, economist at Berenberg, the investment bank. He added: “In our view, economic developments will very likely fall short of this near-perfect scenario and . . . policymakers may eventually need to do more to support the recovery.”
The BoE has become more sanguine than it was in May about the outlook for the labour market, predicting that unemployment will peak at 7.5 per cent towards the end of the year — much lower than most economists expect.
However, it also warned that unemployment could take much longer than previously thought to return to pre-pandemic lows. This is because the recession has hit labour intensive sectors — such as retail and hospitality — much harder than others, and if they suffer a lasting hit, those who have lost work may not have the skills needed to fill the jobs available.
The BoE also warned of more lasting damage to the economy, with its forecast showing GDP 1.5 per cent below its pre-pandemic trajectory at the end of 2023. This long-term scarring is because business investment and start-up activity is expected to remain weak, weighing on productivity.
The bank’s Financial Policy Committee said companies continued to face a severe cash-flow shock, with many likely to need further finance to survive the disruption. It predicted that if the economy followed the path set out in the BoE’s central projections, companies could face a cash-flow deficit of up to £200bn in this financial year.
But the FPC said that even with corporate insolvencies set to rise, UK banks’ capital buffers were more than sufficient to absorb losses — unless the loss of output and the unemployment rate were double that in the MPC’s central projection.
It also made it clear that it wanted banks to continue lending to cash-strapped businesses, saying it would be “costly for them and for the wider economy to take defensive actions”, and that it was in their collective interest to continue supporting households and businesses.
The pound rose 0.4 per cent against the US dollar to $1.3160 after the decision, its highest level since the turmoil in March as coronavirus concerns raced through markets.