Monday, July 4, 2022

BoE and Sunak join forces to support UK’s Covid economy


Britain’s monetary and fiscal cavalry rode into town on Thursday in a bid to bolster the UK’s economy as England entered its second coronavirus lockdown.

Before financial markets opened, the Bank of England announced it would create another £150bn next year and use that to purchase government bonds, further extending the quantitative easing programme which will now reach £895bn by the end of 2021.

At lunchtime, Rishi Sunak, the chancellor, announced that the government’s furlough scheme, paying up to 80 per cent of wages, would be extended until March, significantly increasing the generosity of the state’s support packages for the winter.

The chancellor’s move tossed almost the entirety of his Winter Economic Plan, announced just six weeks ago, into the dustbin.

Line chart of UK unemployment rate (%) showing Unemployment will be delayed but will probably stay higher for longer

According to both Andrew Bailey, BoE governor, and Mr Sunak, the moves by the BoE and Treasury were “co-ordinated”, but the chancellor had not ordered the central bank to announce the bond buying.

Mr Sunak told the House of Commons that the announcements showed “all economic and monetary institutions are playing their part”.

“The governor and I are in constant communication as the situation evolves,” he said. “Our responses are carefully designed to complement each other, and provide certainty and support.”

But the BoE was blindsided early on Thursday by an apparent leak of its policy decision to The Sun newspaper, which central bank officials were worried had come from parts of the Treasury or Number 10. Mr Bailey said the BoE would “look into it” and set up an internal inquiry into the potential leak.

The governor was adamant that the BoE had not agreed to raise government bond purchases by £150bn to finance Mr Sunak’s plans, saying that it did not set the level of QE “in any way related to what the government is going to borrow”.

But the governor refused to answer questions on how the bank’s Monetary Policy Committee decided that £150bn was the right amount of QE and what the consequences would have been had it decided to print more or less money.

“We don’t do a counterfactual forecast,” he said, declining to reveal how much difference he thought the central bank’s QE programme would make, nor what was in the BoE staff “benchmark forecast”, which is presented to the MPC to aid its discussions.

The MPC’s minutes said the decision to loosen monetary policy was taken with “risk management considerations” in mind. “Announcing further asset purchases now should support the economy and help to ensure that the unavoidable near-term slowdown in activity was not amplified by a tightening in monetary conditions that could slow the return of inflation to the target,” MPC members agreed.

Line chart of UK CPI inflation (annual % change) showing Inflation is set to be higher next year than previously thought

The committee said it would continue the money printing and bond purchases at its current pace during 2021, but retained the flexibility to step up the pace if financial conditions were to “worsen materially” or slow them down if the economy was performing strongly.

Allan Monks, UK economist at JPMorgan, said the BoE’s package was “huge” and reduced the need for the central bank to consider pushing interest rates — currently 0.1 per cent — into negative territory in 2021.

“The size of the package will send a strong signal that [the BoE] is providing ample cover for the still huge borrowing needs of the government over the coming year,” he added.

At the Treasury, Mr Sunak wasted little time in outlining a much more generous package of support than he had offered even at the weekend when the latest lockdown was hastily announced.

His U-turn on ending the job retention scheme was welcomed and the BoE said it would delay pain in the labour market, keeping unemployment lower for longer.

The bank’s forecast still had unemployment rising from the current 4.5 per cent rate to 7.75 per cent next summer after the furlough scheme is set to expire, but it did not expect the double-dip recession it predicted to have an immediate effect on joblessness.

Line chart of UK GDP, Q4 2019 = 100 showing The Bank now expects a double-dip recession

Dave Innes, head of economics at the Joseph Rowntree Foundation, said Mr Sunak was “right to acknowledge that the health crisis and its economic impacts are likely to last well into the next few months”, and the move to extend the furlough scheme would allow businesses to plan through the winter.

But other economists were critical of the government for keeping jobs that were likely never to be viable in suspended animation. Len Shackleton, research fellow at the free-market Institute of Economic Affairs, said the chancellor was, “keeping substantial numbers of people in artificial employment”.

The BoE itself said there would be scars felt in the labour market and other parts of the economy from the lasting impact of Covid-19, estimating that they would leave the economy 1.75 per cent smaller at the end of 2023 than the bank had expected before the pandemic struck.

Unemployment rates would be higher for a prolonged period, the bank’s monetary policy report said, because some people would find their skills were no longer as relevant and longer term scars would include weaker business investment and productivity growth.

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