By David Milliken

LONDON (Reuters) – The Bank of England is likely to ease its foot off the stimulus pedal and reduce its pace of bond purchases next week as Britain’s economy appears to be bouncing back sharply from its COVID pandemic slump.

Retailers and restaurants are reopening, retail sales exceeded pre-pandemic volumes in March and purchasing managers’ indexes in April hit their highest since 2013 as a rapid vaccination programme helped reduce a devastating flood of COVID-19 cases at the start of the year to a trickle.

Just over three months ago, financial markets saw a roughly 50% chance that the BoE would need to cut interest rates below zero for the first time later this year.

Now speculation has turned to whether its Monetary Policy Committee will begin to raise rates from their current 0.1% towards the end of 2022.

“The MPC is in neutral mode, but markets are looking forward towards the point where the MPC will begin to leave its ultra-loose stance,” Investec economist Philip Shaw said.

A first step is likely to come next week if the BoE slows its government bond purchases from the current pace of 4.4 billion pounds ($6.14 billion) a week, according to Shaw and several other economists.

Unlike the U.S. Federal Reserve or the European Central Bank, which committed to open-ended bond purchases to support their economies, the BoE set specific targets.

The BoE’s 875 billion-pound government bond purchase target is supposed to be reached at the end of 2021 but unless it slows the current pace, either now or in June or August, it will hit the goal about three months too soon.

RECOVERY REBOUND

The alternative for the BoE would be to increase its target, as it did repeatedly in 2020, but the much improved economic outlook makes this unlikely.

In February the BoE forecast the economy would grow 5% this year after output slumped by almost 10% the year before, the biggest decline in over 300 years.

Now some economists, including Shaw, think growth is on track to exceed 7% this year, returning output to around its level before the pandemic.

Goldman Sachs says British growth in 2021 will outpace that in the United States, which experienced a much milder downturn last year.

Helping the economy is the continued support from finance minister Rishi Sunak who has extended his job support measures until the end of September – when the economy is supposed to be fully reopened – and prolonged tax incentives for house purchase that have fuelled a boom in property sales.

BoE Deputy Governor Ben Broadbent has said he expects “very rapid growth” over the coming quarters but warned that could mask underlying economic weakness.

“They are going to come out with a new, more positive set of economic forecasts and at the same time they will be trying to dampen down market expectations that that is going to lead to faster rate increases,” Thomas Pugh of Capital Economics said.

The BoE has said a rapid rebound does not mean policy would need to be tightened quickly. First, it wants to see inflation sustainably back near its 2% target and progress towards resolving the hit to the labour market created by the pandemic.

The BoE also expects trade frictions created by Brexit will be a persistent drag on growth.

A final complication is that the BoE is reviewing whether to prioritise bond sales over rate rises when it tightens policy, after concerns last year from Governor Andrew Bailey at the scale of past purchases.

($1 = 0.7168 pounds)

(Reporting by David Milliken; Editing by William Schomberg and Alison Williams)