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Central banks need to help to offset the virus impact

The Bank of England has left us in the dark about how much quantitative easing we can expect month-by-month as 2020 passes into 2021. It’s time for better communication and action.

The Bank of England has left us in the dark about how much quantitative easing we can expect month-by-month as 2020 passes into 2021. It’s time for better communication and action.

by
Charles Stanley

in Features

06.11.2020

On Friday morning, with the results of the US presidential election still unknown, we stay with our forecast that the US Presidential election is Joe Biden's to lose.

Joe Biden is now very close to picking up the remaining Electoral College votes he needs to become President-elect, with four swing states still to declare. Each of them is very close, with the gap narrowing against Donald Trump with postal ballots likely to boost Democrat tallies.

Many Republicans back Mr Trump in thinking there is large-scale electoral fraud in the mail votes, but, so far, there is no public evidence offered to sustain a successful legal challenge to any of the main swing-state contests. To change the election for him, he is likely to need convincing proof of enough rigged or false ballot papers to swing more than one state's declared result.

This week, we have seen the Bank of England produce new forecasts of the world and UK economies. It has also announced further quantitative easing, offering an additional £150bn of purchases of UK government bonds over the period to the end of 2021.

This takes the overall total to £895bn, including £20bn of corporate bonds which they are not increasing. This latest announcement will help keep bond rates down well into next year – and give further cover for the government's plans to borrow extensively to cushion the effects of another lockdown of significant sections of the economy.

Inflation an issue?

The Bank of England forecasts a return of inflation to 2% by the end of next year, with low inflation of 0.6% this year. To get there it assumes a further small reduction in official interest rates – in line with current market expectations – which, in turn, have been generated by the Bank itself consulting on a possible later use of negative rates. It acknowledges that such a move would not make much difference to raising the inflation rate, and would also only add a small amount to their output forecast.

The tortured text of the MPC's report shows us a central bank struggling to come to terms with the magnitude of events this year. Never have they – nor any of us – seen such large falls in world or domestic output as a result of government policy decisions, taken in the good cause of stopping a pandemic.

It has made government finances in the major countries look as if they are fighting a major war where you do not worry about the money as you seek victory or survival. They rightly claim that there is currently unused capacity explaining the very low inflation, and probably underestimate that unused capacity by a wide margin. They argue that this unused capacity will be eliminated over the next couple of years, whilst also asserting that the structural change will be much less dramatic than it was in the last century with the decline of UK manufacturing. This is altogether more questionable.

Like many commentators, the Bank of England agonises over whether more home working will boost productivity or not. It points out many working at home give some of the saved time from commuting to their employers, whilst others lack the incentive or drive that comes from working with colleagues directly in the same room. So far, it looks as if productivity in white-collar areas where home working is feasible has held up well. It completely ignores the areas where output and productivity declines have been large. In health, for example, it expresses a hope that more doctor consultations online will herald higher productivity for the sector, yet the overall figures show a big drop in NHS output for non-Covid activities, which is highly visible in the overall GDP figures for the last two quarters.

Property conundrum

The central bank ducks the difficult question of what is going to happen to all the empty office blocks when rents come due for review and leases for renewal. The truth is, economies hit by Covid-19 are likely to go through a long, accelerated period of structural change, as the digital and green revolutions sweep on. They do document the big switch to online activity in retail and suggest that will boost productivity in that sector. That will only happen if – and when – the shops are closed and the grisly task of making staff redundant takes place.

The report fails to spell out what is under its control. We are left in the dark about how much quantitative easing we can expect month-by-month as 2020 passes into 2021. We are not told what if anything, it is to do about the credit tightening it reports in the real economy.

Mortgages are getting more expensive and scarcer, especially for those who lack a large deposit. There is also a reported tightening of consumer credit. Given the acceptance of spare capacity and underemployment, this is a good time for those who can to borrow to buy the bigger items available. There has overall been a substantial rise in personal savings, but much of this is concentrated in the better-paid part of the population who have not had the same opportunities to spend their incomes with holidays, meals out and smart hotels off the agenda.

The Bank of England sees the world economy declining by 4.5% this year and recovering by 7% next year. It thinks that in 2021 the UK will grow by 7.25% and the Euro area by 6% after weak performances by both in 2020. These are perfectly reasonable guesses in a very uncertain world. It all depends on the progress of the virus, the developments on treatments and vaccines and the public policy responses seeking to balance public health issues with jobs and incomes.

With Mr Biden in the White House, mail ballots and courts permitting, there will be a concert of government policies on both sides of the Atlantic both to take the virus seriously and to ‘build back better’ with plenty of green policy. That is a recipe for massive structural change, with many losers as well as winners. The Bank skirts round the issue of how much capital will be written off if we travel this track because the numbers are so large and there is no clear peacetime precedent. We must now look to the Fed to keep markets happy with their much larger firepower. It will be needed as the US embarks on a highly contentious and contested change of President.

The Fed promised accommodative policy and pledged to go on buying bonds at least at the current rate. With the political uncertainties raging around its caution whilst awaiting an election result is understandable. In December, it will need to be more positive, as a suitable fiscal stimulus which they recommend is unlikely to be agreed any time soon.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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