Morning Commentary: The Bank of England: Cautiously Optimistic
A daily summary and commentary of events and factors that affect the global markets, with a particular emphasis on the foreign exchange markets.
The Bank of England: Cautiously Optimistic
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Andrew Kositkun Senior FX Advisor
The Bank of England (BoE) meets this Thursday in what should be more stocktaking than policymaking, with the bank widely expected to maintain policy as is. When it comes to the bank’s forecasts, the BoE will need to account for not only better-than-expected data but also a boost from the government’s budget. First-quarter gross domestic product is likely to come in far better than the bank’s February forecasts. This, in conjunction with the boost from the March 2021 budget, should allow the bank to upgrade its outlook for the year.
However, as the bank noted in February and reiterated in March, it will be cautious not to carry over too many of the short-term upside surprises into its medium-term forecasts. The BoE’s medium-term outlook already skews toward the optimistic side. If the bank were to carry over short-term upward revisions into materially higher medium-term upgrades, it would run the risk of indicating earlier-than-desired policy tightening. Moreover, some of the improved near-term outlook represents a pull forward of demand and the UK’s fiscal policy is set to become highly contractionary from 2022 onwards.
Similarly, the BoE’s labor market forecasts will have to account for largely positive labor market developments — particularly the March and April surveys. Additionally, and arguably more importantly, the bank will need to account for the extension of the government’s furlough scheme to the end of the third quarter. This extension should lower the near-term peak unemployment level, but with the bank’s medium-term unemployment forecasts already skewed positive, it is unclear how much more the bank will improve its medium-term labor market outlook, as it doesn’t want to prematurely offer a policy signal.
When it comes to the pound, how the BoE views the outlook beyond the expected sugar rush and its ramifications for rates is arguably the most significant factor. Foreign exchange markets have priced out the possibility of negative rates. As such, expect markets to key in on the BoE’s appetite to forecast rate normalization in 2022.
Beyond the central bank, this week also brings elections in England, Wales and Scotland. Looking at Scotland specifically, these elections will determine not only who gets to govern but also whether or not there will be a new referendum on independence from the rest of the U.K. Polls currently show that an outright Scottish National Party (SNP) majority remains possible. Failing this, a pro-independence plurality is very likely, as polling shows pro-independence parties (SNP, Greens, Alba) are comfortably above the 65-seat threshold. However, it should be noted that a pro-independence coalition scenario, relative to an outright SNP majority, would mean a lower likelihood of an independence referendum.
Regardless of the election outcome, significant political and constitutional hurdles remain before Scotland is able to hold another independence referendum. Further, the process of independence could take many years given the internal and external economic rebalancing that an independent Scotland would face. Clearly, a fast-tracked EU membership would help, but as with Brexit, whether or not independence will result in an improvement of the current situation will depend on a long list of policy decisions. As for the rest of the U.K., Scottish independence would be less disruptive than Brexit but would still be painful. At a minimum, it would divert resources into managing this complex process and away from other issues, possibly leading to protracted economic weakness relative to peers.
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