Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
BoE Call: Looking for QE increase of £150bn and overall ultra-accommodative message
Christopher Dembik
Head of Macro Analysis
Summary: We are onside with consensus in expecting a significant increase in the BoE's QE to mitigate the negative effects of the pandemic and Brexit uncertainty. Our baseline scenario is an increase of GBP 150bn which would push the total stimulus package to about GBP 795bn. The overaching message should remain ultra-accommodative with potential reference to negative rates if conditions require further support.
BoE Preview : Following the unprecedented 20.4% contraction in GDP in April and downside risks weighting on the economy due to the pandemic and Brexit uncertainty, the Bank of England is likely to unleash more firepower to support the economy on Thursday. QE increase was already on the table at the latest MPC meeting with two members – J. Haskel and M. Saunders – voting in favor of an increase of £100bn. Since the beginning of the crisis, the Bank of England’s strategy consists in absorbing more public debt than the Treasury is selling in order to allow the private sector to reduce its holdings of gilts. If it wants to continue this strategy and sustain the current pace of gilt purchases, we estimate that the central bank will need to increase the QE package by £150bn this week. The new stimulus would last at least until September or even November in case the Bank of England decides to slow purchases if market conditions improve significantly.
Market focus will be on what policymakers have to say about negative rates. In one of its latest speech, the governor Andrew Bailey has not ruled out this policy. In our view, it is however unlikely to materialize any time soon due to the detrimental impact of negative rates on banks and lenders’ margins. Implementing them now would be the worst time ever for the banking and financial sector which faces already a very challenging period due to Brexit uncertainty and the threat of bad loans.
We think a more promising policy response would be to implement yield curve control, as was done by the Bank of Japan and the Federal Reserve (from 1942 to 1951). Along with a clear and well-crafted communication strategy, the Bank of England could avoid interest rates from increasing too much when the recovery will start to materialize. It would allow the government to keep borrowing at low cost on the market as much as necessary to boost aggregate demand. The easiest strategy consists in keeping the 10-year yields within a certain range, let’s say between 0% and 0.10%, but other options exist such as targeting interest rates only in the short portion of the yield curve (e.g. up to two years) or beginning at the short end of the yield curve and moving out in steps as needed.
Rate expectations : Unchanged at 0.1% - the lowest historical level.
Possible QE tweak expectations : QE increase of £150bn – total stimulus package expected to reach £795bn.
Latest BoE projections:
· GDP : -25% (Q2 2020), -14% (2020), +15% (2021).
· UK GDP is expected to recover its pre-COVID peak in the second half of next year.
· Unemployment: 9% (Q2 2020).
· Inflation: 0,6% (2020), 0,5% (2021).
OCDE projections:
· 2020 GDP: -11,5% (single pandemic peak), -14% (second pandemic peak).
· 2021 GDP: +9%.
IMF projections:
· 2020 GDP: -6.5%.
· 2021 GDP: +4%.
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