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 is to respond to the severe economic and financial disruption caused by the spread of Covid-19. At its meeting ending on 6 May 2020, the MPC voted unanimously to maintain Bank Rate at 0.1%. The Committee voted by a majority of 7-2 for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to take the total stock of these purchases to £645 billion. Two members preferred to increase the target for the stock of asset purchases by an additional £100 billion at this meeting.
The spread of Covid-19 and the measures to contain it are having a significant impact on the United Kingdom and many countries around the world. Activity has fallen sharply since the beginning of the year and unemployment has risen markedly.
Economic data have continued to be consistent with a sudden and very marked drop in global activity. Oil prices have been volatile. There have, however, been tentative signs of recovery in domestic spending in China, and this is likely to be echoed in other countries that have started to relax Covid-related restrictions on economic activity. Financial markets have recovered somewhat over recent weeks and risky asset prices have picked up from their lows in mid-March. This in part reflects the actions taken by authorities in the United Kingdom and elsewhere. Global financial conditions have, nevertheless, remained tighter than prior to the outbreak of Covid-19.
The timeliest indicators of UK demand have generally stabilised at very low levels in recent weeks, after unprecedented falls during late March and early April. Payments data point to a reduction in the level of household consumption of around 30%. Consumer confidence has declined markedly and housing market activity has practically ceased. According to the Bank’s Decision Maker Panel, companies’ sales are expected to be around 45% lower than normal in 2020 Q2 and business investment 50% lower. There has been widespread take-up of the Coronavirus Job Retention Scheme. Nevertheless, sharp increases in benefit claims are consistent with a pronounced rise in the unemployment rate.
CPI inflation declined to 1.5% in March and is likely to fall below 1% in the next few months, in large part reflecting developments in energy prices.
The unprecedented situation means that the outlook for the UK and global economies is unusually uncertain. It will depend critically on the evolution of the pandemic, and how governments, households and businesses respond to it. Recognising these uncertainties, the MPC has constructed a plausible illustrative economic scenario in the accompanying May Monetary Policy Report. This scenario is based on a set of stylised assumptions about the pandemic and the responses of governments, households and businesses, and, as usual, on the prevailing levels of asset prices and the market path for interest rates. While the scenario is highly conditional, it helps to illustrate the potential impact of Covid-19 on the economy and the channels through which the impact is felt. The Report also includes a number of estimates of the sensitivity of the economy to a selection of key variables, which, taken alongside the scenario, serve to illustrate the important drivers of the outlook.
The illustrative scenario incorporates a very sharp fall in UK GDP in 2020 H1 and a substantial increase in unemployment in addition to those workers who are furloughed currently. Given the assumed path for the relaxation of social distancing measures, the fall in GDP should be temporary and activity should pick up relatively rapidly. Nonetheless, because a degree of precautionary behaviour by households and businesses is assumed to persist, the economy takes some time to recover towards its previous path. CPI inflation is expected to fall further below the 2% target during the second half of this year, largely reflecting the weakness of demand.
As set out in the accompanying interim Financial Stability Report, the Financial Policy Committee (FPC) has assessed the risks to UK financial stability and the resilience of the UK financial system to the economic and market shocks associated with Covid-19. Drawing on the MPC’s illustrative scenario, the FPC judges that the core banking system has capital buffers more than sufficient to absorb losses and, supported by government guarantees for new lending and Bank of England funding, the capacity to provide credit to support the UK economy.
The MPC has statutory objectives to maintain price stability and, subject to that, to support the economic policy of the Government including its objectives for growth and employment. In the current circumstances, and consistent with the MPC’s remit, monetary policy is aimed at supporting businesses and households through the crisis, and limiting any lasting damage to the economy.
Since the onset of the Covid-19 shock, the MPC has, complementing the responses of other parts of the Bank of England and the UK Government, taken a number of actions to fulfil its mandate. The Committee has reduced Bank Rate to 0.1%; has introduced a Term Funding scheme with additional incentives for Small and Medium-sized Enterprises (TFSME); and announced a £200 billion increase in the stock of UK government bond and sterling non-financial investment-grade corporate bond purchases, to be carried out as soon as operationally possible and consistent with improved market functioning. The Committee notes that the stock of asset purchases will reach £645 billion by the beginning of July, at the current pace of purchases. The Committee continues to monitor closely a range of indicators of market functioning.
In the illustrative scenario, the recovery in economic activity is relatively rapid and inflation rises to around the 2% target, conditional on the scenario assumptions that include a gradual easing in social distancing, and supported by the very significant monetary and fiscal stimulus. Relative to the scenario, the Committee assesses that the balance of risks to the economic outlook lies to the downside.
At this meeting, the Committee judges that the existing stance of monetary policy is appropriate. The MPC will continue to monitor the situation closely and, consistent with its remit, stands ready to take further action as necessary to support the economy and ensure a sustained return of inflation to the 2% target.