The Bank of England’s Monetary Policy Summary today didn’t disappoint despite the amount of hype in the build up.
While many anticipated the BoE would maintain its current policy stance in light of the recent economic headwinds posed by the national lockdown measures, which the central bank expects to cause a 4% drop in GDP in 2021 Q1, the MPC gave long-awaited clarity over the operational viability of negative rates in the UK financial system. While the Bank trod cautiously in the way it signalled its intentions, it ultimately clarified that negative rates are a tool that can be used in the future should conditions warrant them. They instructed the Prudential Regulation Authority to engage with PRA-regulated firms to begin the preparations to implement a negative Bank Rate, allowing six months for firms to make this operational feasible.
Despite this announcement, sterling shot up from session lows to trade in the green against the dollar while the sterling overnight index average (SONIA) curve shifted upwards to price out the possibility of negative interest rates this year.
This may seem confusing considering the BoE signalled for financial institutions to get their systems ready, but it is merely a by-product of the way in which the implementation of negative rates was communicated throughout the document. In the two-page breakdown, there was repeated reference to the fact that this move by the BoE shouldn’t be considered as forward guidance on rates. This was hammered home by the Bank when it stated that the “current conjuncture and the outlook described in the MPC’s latest economic projections” didn’t warrant negative interest rates to even be discussed past an operational formality. Additionally, some MPC members dissented to the Bank even asking for financial institutions to prepare their systems for future reference.
On the whole, the green light for negative interest rates was delivered to markets in a net hawkish manner.
The communication of such a policy was always going to be key to how markets priced the decision, however, the Bank’s job isn’t over just yet. Governor Bailey will have to walk a very tight line if he is to avoid undoing all of the work the monetary policy summary has already done and stoke expectations of negative interest rates in 2021 again when he takes questions from reporters at 13:00 GMT.
POST PRESS CONFERENCE: BANK OF ENGLAND DOUBLES DOWN ON HAWKISH TONE IN THE PRESS CONFERENCE
The risks to Governor Bailey’s press conference were largely centered around communicating the Bank’s view on negative interest rates. While communications were the problem to begin with, mainly because the stream kept collapsing, MPC members didn’t walk back the net hawkish message struck in their initial statements. Instead, questions around the pace of QE saw the Bank of England double down on their initial tone to deliver an even more hawkish message to markets, which saw sterling extend its rally against both the dollar and the euro. In response to a question on the pace of QE purchases, Deputy Governor Ramsden stated that the BoE would have to slow purchases at some point but are on track to complete the QE programme by year-end. While the Bank can still extend its QE programme, like it has done twice since March 2021, the mere discussion of QE tapering send gilt yields higher yet again and provided another tailwind for the sterling rally.
However, the strength of the message sent by the Bank of England is concerning given how much uncertainty still pertains to the economic outlook. New strains of Covid-19 and the efficacy of the vaccines currently deployed against them means that the path of the economic recovery isn’t as clear cut as the message BoE members signaled today. The result of which could see Governor Bailey be dubbed an “unreliable boyfriend”, similar to what his predecessor Mark Carney was labelled.
While this is a longer-term risk, and one which may have been mitigated somewhat by the Bank’s decision to make negative rates operational to potentially sue in the future, sterling continues to look the other way as it rides high on the move in fixed income markets.
SONIA curve shifts higher to price out negative interest rates in 2021 after BoE statement
Sterling takes another leg higher as BoE members double down on hawkish message in the press conference
Author: Simon Harvey, Senior Market Analyst