The Bank of England held interest rates at 0.1 per cent and is forecasting stronger than expected growth for the UK economy.
At the latest Monetary Policy Committee meeting, the BoE revised its economic growth forecast is are now anticipating 7.25 per cent GDP growth in 2021. This is an increase from the 5 per cent three months ago and would mean a full economic recovery from the Covid-19 pandemic by Q4 this year.
The BoE added that the pace of GDP growth is expected to slow down after 2021 as the boost from factors such as rapid vaccine programme, fiscal and monetary stimulus and pent up consumer spending wane.
In the minutes of the meeting, the MPC said: “The outlook for the economy, and particularly the relative movement in demand and supply, remains uncertain. It continues to depend on the evolution of the pandemic, measures taken to protect public health, and how households, businesses and financial markets respond to these developments.”
The BoE forecasts that as the economy experiences a period of stronger GDP growth there may be “a temporary period of modestly above-target CPI inflation”, but it expects growth and inflation to fall back with inflation around the 2 per cent target in two and three years’ time. It will continue to monitor and adjust monetary policy when necessary.
Jon Hudson, manager of Premier Miton UK Growth fund, said that there is a risk the economy might “overheat” in the future, but at the moment this is a positive outlook for the UK.
He said: “The MPC is now expecting a faster economic recovery than previously expected, led by households spending their forced savings accumulated over lockdowns.
“High demand and rising commodity prices will cause inflation to rise in the near term but medium-term expectations remain unchanged, allowing the MPC to keep financial conditions loose.
“This inevitably increases the risk that the economy may overheat further down the line but for the time being it bodes well for domestically focused UK businesses.”
Gurpreet Gill, macro strategist for global Fixed Income at Goldman Sachs Asset Management, said the bank remains underweight UK assets.
“As expected, the Bank of England (BoE) acknowledged improvements in the growth outlook owing to vaccinations picking up pace but kept the policy rate unchanged," she said.
"The Bank tapered asset purchases which was to some extent expected as the continued pace would see the Bank exceed its QE envelope, hence the relatively muted market response."
"We continue to think rate hikes are a distant prospect, in part due to the BoE indicating it may seek to reduce the size of its balance sheet before normalizing rates."
“The rationale for this is three-fold. First, QE is intended to ease market stress and so it is prudent to reduce the balance sheet size to create room to expand the balance sheet in the future. Second, there is potential for rates to fall from current levels. And third, like the Bank of Canada, the BoE will be conscious of its enlarged footprint in UK fixed income markets.
“Nonetheless, we think market-implied pricing for BoE policy is dovish relative to G10 peers and its macro trajectory. As such, we are biased to be underweight UK rates on a cross-market basis.”
One thing investors should bear in mind is to not confuse these positive near-term growth prosects with the UK’s long-term outlook, according to Vivek Paul, UK chief investment strategist at BlackRock Investment Institute.
He said: “The MPC now sees the UK ‘restarting’ from the Covid shock at a faster pace than it expected in February. Activity has been more resilient through the latest national lockdown, the chancellor announced a further spending boost in his March Budget and new US fiscal support has been notably stronger than expected. Indeed, the MPC brought forward its forecast of when GDP returns to its pre-Covid high.
“Yet, it would be a mistake to extrapolate from eye-watering growth rates in the near term to stronger growth in the future: after all, this is a restart, not a recovery. As activity returns to its pre-Covid trend, growth will likely return to a more normal pace.”
On inflation, Paul added that the new forecast indicates “greater volatility in the near term” as the UK economy deals continues to deal with Covid-19.
Medium term, or “the crucial horizon for its policy decisions,” he expects inflation to return to target following a moderate overshoot.
“Long-anticipated RPI reform has not materially dented long-run breakeven inflation expectations priced into UK index-linked bonds; but we would caution against UK investors with liabilities unwinding inflation hedges on the grounds that they are therefore now more expensive,” he finished.
“You would also need to believe that they will get cheaper, and our conviction would be low – we believe that global inflation remains underappreciated on a strategic horizon and structural supply and demand imbalances show no signs of abating as index-linked issuance remains constrained.”