Bank of England: Three things to look for this Thursday

The Bank of England’s new forecasts could follow a similar blueprint to the European Central Bank, which last week laid out three scenarios based on different speeds of reopening/recovery. That means the Bank doesn’t need to make a formal assumption about the reopening process, something the UK government is set to unveil later this week.

Our own forecasts published back in April assumed around a 10-15% peak-to-trough fall in output (when measured on a quarterly basis), although we wouldn’t be surprised to see the Bank of England pencil in a sharper decline. In the end, the precise size of the fall is a little academic now - more relevant is the speed and shape of the recovery.

We expect this process to be fairly gradual, not least because some firms will not emerge from the crisis in the same shape, despite the government’s best efforts. That, in turn, means unemployment could stay reasonably elevated for a prolonged period of time.

We’d expect the Bank of England to also push back on the idea of a ‘V-shaped’ recovery this week.

The BoE’s £200 billion QE package was larger than expected when it was announced back in March, and for the time being, gives policymakers plenty of scope to keep expanding the balance sheet.

From a flow point of view, there is no rush to expand the size of the QE target this week. For one thing, purchases remain well below the £645bn QE ceiling the BoE has set itself: the size of the QE portfolios have reached £514bn in total last week, of which just under £12bn is in corporate bonds. Extrapolating the current pace of purchases, we estimate the BoE has just under two more months to go before reaching the ceiling, more if it tapers purchases.

Another argument for upping the target would be to absorb additional Gilt issuance. So far this calendar year, the Debt Management Office (DMO) has sold £81bn of Gilts (before redemptions). For comparison, BoE purchases started only in Mach but have since removed £77bn of paper from the market, most of what has been issued in 2020.

This balance is about to change in the coming months. The DMO has announced it will sell 180bn of Gilts in the three months to July. This is a step change from previous borrowing plans that foresaw £156bn for the whole 2020-21 fiscal year. At the current pace, we estimate Gilt supply will exceed BoE purchases by a mere £7bn in the two coming months. After that, the only way to avoid a ‘cliff-edge effect’ is to expand the current programme, or at least to phase it out.

Our view that this meeting will be used by the BoE to ‘take stock’ of the effect of the measures announced so far is reinforced by the improvement in money market conditions. We are far from sounding the all clear but some indicators suggest a normalisation. For instance, Libor-OIS spreads have tightened back suggesting an easing of systemic risk in the banking system.

Granted, the same phenomenon has been observed in other jurisdictions but we note some anecdotal evidence of improvements in sterling money markets specifically. For instance, the Top/Top index of Commercial Paper rates indicates a cheapening of borrowing cost for high-rated companies and banks, after over two months of not publishing due to a lack of underlying transactions.

This brings us to the third item on the list. The BoE’s commercial paper purchasing scheme (or CCFF as it is formally known) is perhaps a lesser-known, but arguably one of the most important, parts of the Bank’s Covid-19 war chest.

It was designed at a time where the CP market was perceived to have dried up amid the global rush for cash. Like the Federal Reserve's similar scheme, the BoE aimed to return this key source of funding for corporates - and in turn reduce pressure on the Banks to provide funding through revolving credit facilities.

Tentative signs of improvement in money markets are a credit to the CCFF. We noted at the time of its launch that the mandated buying levels were aggressive enough to trigger a re-tightening to OIS. And the BoE seems to be putting in the work. Last week, it reported £15.9bn of CP holdings, with a £5.0bn increase from a few days earlier. This is also a step up from the previous programme launched in 2009 that saw its holdings of CP peak at £2.3bn.

There are other reasons to be optimistic: fiscal and monetary authorities are pushing in the same direction. The latest quarterly DMO issuance programme included no plan to increase the amount of T-bills in circulation. In our view, this removes a key risk for the sterling money market: that of government issuance crowding out private issuers.