BOE’s Vlieghe: Risks Skewed Towards Weaker Economic Developments than Main Scenario

22 February 2021

By David Barwick – Frankfurt (Econostream) – The further evolution of the pandemic could lead to weaker economic developments than the MPC’s main scenario, an outcome under which additional accommodation in the form of a negative Bank Rate would be appropriate, Gertjan Vlieghe, external member of the BOE’s Monetary Policy Committee, said on Monday.

In a speech at Durham University, Vlieghe, according to a text of his remarks made available by the BOE, said that his ‘own view is that risks remain skewed’ in the direction of a weaker economic scenario than the MPC’s central projection.

For one thing, he explained, the pandemic could continue to weigh because of mutations or slower vaccination progress outside the UK. For another, as the UK eases out of the furlough scheme put in place to cushion the economic impact of the pandemic, not all workers will rejoin the job market effortlessly, he said.

The consequence could be relatively persistent and disinflationary labour market slack compared to that envisioned by the MPC, he said, depressing wages and preventing inflation from a durable return to target.

‘In such a scenario, I judge more monetary stimulus would be appropriate, and I would favour a negative Bank Rate as the tool to implement the stimulus’, he said. ‘The time to implement it would be whenever the data, or the balance of risks around it, suggest that the recovery is falling short of fully eliminating economic slack, which might be later this year or into next year. After the further boost delivered by negative rates to eliminate slack, interest rates can begin to return to positive.’

In contrast, economic developments consistent with the central projection of the MPC in February would probably imply no need of further accommodation, he said. ‘The current stance remains appropriate, and we will just complete the already announced QE programme’, he said.

However, with the neutral rate of interest very low, he said, there would be ‘no hurry at all to remove stimulus.’ Vlieghe said his preference would be ‘to keep the current monetary stimulus in place until well into 2023 or 2024, long enough to judge whether economic slack has indeed been eliminated fully, and inflation has returned to target sustainably, rather than being pushed up by temporary factors.’

Although the economy could develop better than the central projection, for example if a higher proportion of accumulated savings were spent, it would be necessary to judge how sustainable this was, ‘so I would favour not responding to the first signs of it, as long as inflation expectations remain anchored’, he said.

Reacting too quickly ‘would be a policy error’ and indeed ‘a worse mistake than tightening too late, given that monetary policy space for easing is limited’, he said. ‘So even if the economy recovers more strongly than in our central projection, I think removal of monetary stimulus is unlikely to become appropriate until well into 2022.’

Low neutral interest rates mean the MPC probably ‘would not have to tighten all that much’, he added.

Vlieghe said that the MPC would not hesitate to pick up the asset purchase pace again if market functioning deteriorated anew and QE were thought to be useful for restoring inflation to target.

‘But absent such a deterioration, and with long term interest rates already very low, we need to look for tools other than QE to deliver further stimulus if required’, he said. ‘It is therefore an important and welcome development that the MPC will be adding negative interest rates to its toolkit from August, once banks have made the necessary operational adjustments.’

As of then, he said, negative rates would satisfy the feasibility requirement. Similarly, ‘the large amount of evidence gathered from countries that already have negative rates’ confirms their effectiveness in the sense that they ‘stimulate the economy and lending relative to a counterfactual where rates are not cut any further’, he said.