The Bank of England will stick with its emergency policy setting until it is sure the economy’s recovery from the Covid-19 slump is more than a summer bounce, Threadneedle Street’s governor has said.
Andrew Bailey told a symposium of fellow central bank governors that the Bank’s decision to “act big and act fast” during the early stages of the pandemic had proved an effective response to the market panic and economic lockdown.
He said that the Bank’s nine-strong monetary policy committee would need a “stronger-than-usual body of evidence” before it would consider removing any of the stimulus provided over the past six months.
Bailey, making a virtual appearance at the Jackson Hole gathering of central bankers, said the Bank would not raise interest rates or sell the assets it had purchased under its bond-buying programme, known as quantitative easing, until there was “significant progress” in eliminating the spare capacity left by the recession and inflation was raised sustainably back to its 2% target.
“This important step is intended to ensure monetary conditions do not tighten prematurely when there are some initial signs of an economic recovery,” he said.
The governor said that in order to act speedily and aggressively in the future, the Bank might need to create “headroom” by selling assets back to the markets, but he stressed that it was nowhere near that point yet.
Britain’s economy contracted by 20% in the second quarter of 2020, but analysts expect that the gradual easing of the lockdown restrictions from May onwards will lead to growth of about 15% in the third quarter.
The Bank responded to the crisis by cutting interest rates to 0.1% and expanding its asset purchases, initially by £200bn and then by a further £100bn, during the summer. Bailey said Threadneedle Street had tried a range of initiatives, including buying corporate as well as government bonds and helping companies with their long-term cash flow.
“There are times when we need to go big and go fast,” Bailey said. “We are not out of firepower by any means, and to be honest it looks from today’s vantage point that we were too cautious about our remaining firepower pre-Covid. But hindsight is a wonderful thing when you have it.”
The governor said the Covid crisis had provided central banks with their first big test since the financial crisis of 2008. “Monetary policy has had to respond to an unprecedented shock. For many central banks, the main tool to date has been further quantitative easing (QE), in unprecedented scale and pace of purchases.”
Under QE, the Bank of England creates electronic money so that it can buy bonds from the private sector. The injection of cash is designed to calm financial markets and increase spending power.
“Viewed from the depth of the Covid crisis, QE worked effectively,” Bailey said. “Measuring this effect precisely is, of course, hard, since we cannot easily identify what the counterfactual would have been in the absence of QE. But QE clearly acted to break a dangerous risk of transmission from severe market stress to the macro-economy by avoiding a sharp tightening in financial conditions and thus an increase in effective interest rates.”
Bailey’s strong backing of asset purchases in his Jackson Hole speech was seen as a strong hint that another dose of QE will be the Bank’s first line of defence in the event that the economy weakens over the coming months.
Alongside Bailey’s remarks, the Bank of England published research setting out arguments for reversing some of its asset purchases before raising interest rates – the opposite of the approach under Bailey’s predecessor, Mark Carney.
The working paper said the impact of quantitative easing depended heavily on the state of the economy, so it could be possible to withdraw some, creating scope for greater future action, without tightening monetary conditions as much as raising interest rates.
“If it is possible to set the appropriate stance of policy using alternative combinations of the policy rate and QE, a combination that provides more space for future QE may be preferable, other things equal,” the Bank said.