The Old Lady has lit something of a fire under sterling: The Bank of England left rates unchanged at the record low 0.1% and the stock of asset purchases steady at £895bn. There was no surprise in either as the Bank has plenty of ammo left in the tin in terms of QE and any thoughts about negative rates are premature to say the least. Indeed I would say that this latest update indicates the next move on rates will be to hike when the recovery takes hold and inflation picks up as spare capacity is eliminated – perhaps not soon but the direction of travel is surely away from negative rates and towards hiking, perhaps in 2022.  Sterling and gilt yields responded by shooting higher, with 2-year yields jumping from -0.1% to -0.05%.

We got a confident outlook too – the Old Lady thinks the UK economy will recover quickly to pre-pandemic levels of output over the course of 2021. It expects spare capacity in the economy to be eliminated as the recover picks up steam this year, which begs the question: is the next move up? I think so, although clearly the Bank is at pains to leave negative rates in the toolkit.  

Key passage: GDP is projected to recover rapidly towards pre-Covid levels over 2021, as the vaccination programme is assumed to lead to an easing of Covid-related restrictions and people’s health concerns. Projected activity is also supported by the substantial fiscal and monetary policy actions already announced. Further out, the pace of GDP growth slows as the boost from these factors fades. Spare capacity in the economy is eliminated as activity picks up during 2021.”

It also stressed that the GDP performance in Q4 was “materially stronger” than it thought in Nov. The thing is lockdowns #2 and #3 are not as economically damaging as mark 1. However 2021 gets off to a slow start – GDP is expected to fall by around 4% in 2021 Q1, in contrast to expectations of a rise in the November Report. This is no surprise since lockdowns are lasting much longer than we thought they would back then. But the important thing is the rapid elimination of spare capacity this year. 

Not only did the BoE say that it does not intend to signal that negative rates are coming, but it also – from my reading of the Monetary Policy Report – suggest that the next move on rates will be to hike. If spare capacity is eliminated this year and inflation progresses to target there will be a move to raise rates. The MPC itself stated: “The Committee does not intend to tighten monetary policy at least until there is clear evidence that significant progress is being made in eliminating spare capacity and achieving the 2% inflation target sustainably.”

But on the face of things, it seems we will see inflation pick up (PMIs are telling us this), whilst oil prices are rising, Brexit will raise some costs inevitably, and pro-cyclical stimulus and vaccines will create a strong tailwind to growth this year. The rapid rollout of vaccines cannot be underestimated as far as inflation goes and the MPC reckons CPI is expected to rise quite sharply towards the 2% target in the spring, and hit 2.5% in 2022. This may be far too conservative. Coupled with a strong economic recovery may present the MPC with a dilemma about when it needs to tighten policy. It could be sooner than expected – it all depends on the vaccines of course so we should treat this with caution.

Sterling liked the MPC taking a bit of step back from the negative rate precipice. GBPUSD advanced to the 50-hour SMA at 1.36470 and reversed the near-term momentum to the downside.