Bank Of England Raises Negative Rate Expectations

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The Bank of England retained its interest rate at a record low on Thursday, but policymakers started to assess how negative interest rates work amid talks on post Brexit trade deal, the recent rise in Covid-19 cases and the rising risk of elevated unemployment.

The nine-member Monetary Policy Committee unanimously decided to hold the interest rate at 0.10 percent, as widely expected. The bank had altogether reduced the rate by 65 basis points at two unscheduled meetings in March.

Policymakers also unanimously decided to retain the size of the asset purchase programme at GBP 745 billion.

The BoE together with the bank regulators will begin ‘structured engagement’ on the operational considerations of negative rates in the fourth quarter of this year.

The key interest rate has never been below zero.

The MPC had been briefed on the BoE’s plans to explore how a negative Bank Rate could be implemented effectively, should the outlook for inflation and output warrant it at some point during this period of low equilibrium rates.

Markets are expecting an expansion to its quantitative easing at the November meeting.

Further preparation for negative rates is likely to be taken as a vindication of market expectations and brings more downside risk to gilt yields, Antoine Bouvet and Petr Krpata, economists at ING, said.

“We remain confident that an increase in the APF is more likely in the near-term,” they said.

Andrew Wishart, an economist at Capital Economics, said he still think that the bank will loosen policy further, most likely in the form of more QE rather than negative interest rates as the market expects.

The bank is expected to add QE by GBP 250 billion over the course of the next year, with an installment of GBP 100 billion in November, Wishart added.

The MPC said it does not intend to tighten monetary policy until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2 percent inflation target sustainably.

Policymakers noted that the outlook for the economy remains “unusually uncertain”.

According to the bank staff, in the third quarter of 2020, GDP would to be around 7 percent below its 2019 fourth quarter level, but less weak than had been expected in the August Report.

CPI inflation is expected to remain below 1 percent until early 2021, albeit slightly higher than expected at the time of the August Report.

As the August inflation was more than one percentage point below the 2 percent target, BoE Governor wrote an open letter to the Chancellor Rishi Sunak explaining the reason for the decline.

Governor Andrew Bailey said the MPC expected a period of low inflation in the near term due to the effects of the Covid-19 pandemic.

He also added that the temporary cut in VAT for hospitality, holiday accommodation and attractions, together with the Government’s Eat Out to Help Out scheme, were expected to lead to a material drop in inflation in August.

In his reply to Bailey, Sunak said the government’s commitment to the BoE’s operational independence and the flexible inflation targeting regime, with an operational target of 2 percent CPI inflation, remains absolute.

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