Bank of England outlines the UK’s economic scenario
The British pound edged higher on Thursday after the Bank of England (BoE) decided to keep interest rates at 0.1% and its quantitative easing programme unchanged at GBP 200bn.
Markets widely expected the BoE to introduce more easing and so the decision to hold rates may have surprised some participants. The bank unanimously voted to keep its interest rate at 0.1% and opted not to increase its quantitative easing programme by a 7-2 majority.
The two members who voted to increase quantitative easing measures dismissed assertions that their decision was not a foregone conclusion, which may explain the pound’s (GBP) boost in foreign exchange markets as currencies tend to react to political and economic surprises.
The pound (GBP) to US dollar (USD) exchange rate (GBP/USD) has bounced from around USD 1.2311 to USD 1.2362 (at the time of writing) and has broken into the USD 1.24 region.
The British pound (GBP) has also retraced some of its losses against the euro (GBP). After the pound to euro exchange rate (GBP/EUR) fell to EUR 1.1402 today, the currency pair is now trading at around EUR 1.1453.
Quantitative easing measures are critical in ensuring the UK financial system can operate successfully and, in turn, allow the government to finance coronavirus related expenditure.
It seems investors are satisfied with the BoE’s decision to leave its interest rates and quantitative easing programme unchanged despite the severity of economic fallout in the UK.
Bank of England British banks can withstand economic fallout caused by COVID-19
Although the Bank of England (BoE) forecast the UK economy to contract by 14% in 2020, the BoE has said that Britain’s leading banks and building societies, such as Barclays, Nationwide and Lloyds could keep lending to the economy.
The BoE came to the conclusion after performing a baseline stress test based on the economic scenario outlined in its Monetary Policy Report (MPR). Under the MPR scenario, UK GDP contracts by approximately 30% during Q2 versus Q4 of 2019 and rebounds as lockdown restrictions ease.
In their interim Financial Stability Report (FSR), the test showed that banks and building societies possess enough capital buffer to withstand more profound losses than that associated in the MPR scenario.
BoE Deputy Governor Jon Cunliffe stressed how important it is for banks to provide financial support and said that failure to do so, would worsen the UK’s overall economic outcome and lead to more significant losses for banks.
To keep credit flowing, the BoE reiterated its advocation for banks to tap into capital and liquidity buffers that are above compulsory minimum requirements. BoE officials also introduced additional ways by which they will ease regulatory burdens to alleviate unnecessary pressures on banks and building societies.
The series of statements given by the BoE also seem to be supporting the pound (GBP) in currency markets, and with Boris Johnson preparing to announce a UK lockdown exit strategy, pound Sterling may see long-term relief.
Boris Johnson drafts 5-step plan to lift the UK out of lockdown
Britain has been in lockdown since mid-March and markets are now expecting the UK to announce phase two of their response to the coronavirus, which would see a relaxation of lockdown measures.
In Prime Minister’s Question Time (PMQ) on Wednesday, Prime Minister Boris Johnson revealed that a detailed plan will be announced on Sunday and hopes that some measures can be eased from the start of next week.
The Mirror reported that the government’s blueprint aims to relax lockdown measures over six months and by following five steps. These five steps are:
- From Monday, employees will be encouraged to return to businesses that have stayed open during the lockdown. Garden centres may re-open and children of key workers’ will return to school. The government will also reduce police powers and introduce new guidelines on the use of outdoor public spaces and travelling.
- From the end of May, primary school children will begin a phased return to schools. If the R rate remains below 1, Britons will be allowed to reunite under the “bubble” arrangement. The bubble arrangement emphasizes meeting outside and only with a small defined group of family and friends.
- Secondary school children will start to return to school from the end of June. Again, if the crisis is still manageable, gatherings of up to 30 people may be allowed, and small team outdoor sports, such as golf and tennis might resume.
- From the end of August, pubs, bars and restaurants may gradually re-open although strict social distancing rules would remain in place. Further advice on the provision of takeaway services is also expected.
Air travel may also see a phased return. British Airways stated that they might begin to operate meaningful travel services from August. IAG Chief Executive Willie Walsh said that operating procedures would be adapted to ensure all customers and employees are protected in this new environment.
- If government officials are satisfied with the R rate and there is a sustained and consistent decline in the number of daily coronavirus cases, remaining areas of the economy may re-open. Fans may be allowed to return to sports matches, and places of worship might re-open.
These easing measures will be closely monitored to ensure the effects of these steps do not cause further harm to the economy, or the public.
Government officials said that if the R rate rises above 1, an ’emergency brake’ could be applied to prevent a second wave of deadly coronavirus infections.
How could the central bank’s monetary policy decision and the easing of lockdown measures affect the pound?
An easing of lockdown measures would place the UK economy on the path to recovery and, as a result, offer support to the pound (GBP) in currency markets.
Although the economy may take time to recover to its previous levels, the UK’s assumed lockdown exit strategy should allow GDP to pick up relatively fast.
However, the potential for further economic stimulus remains a possibility, and foreign exchange strategists at JP Morgan anticipate the pound (GBP) to experience additional weakness.
JP Morgan strategists believe that the UK’s large current account deficit along with excessive quantitative easing will threaten pound Sterling strength. They also expect the BoE to use up its bond-buying programme by July due to inflation and rising unemployment which would necessitate further monetary policy action.