One of the Bank of England’s interest rate setters has warned that inflation pressures are “uncomfortably high” and if the central bank fails to rein these in, it would be “very costly” for the UK economy.
Speaking at the Resolution Foundation think-tank in London on Monday, Michael Saunders, one of the four external members of the BoE’s monetary policy committee, said he wanted monetary policy to stop stimulating economic activity.
Having voted in the minority for a 0.5 percentage point increase last week, Saunders said he thought the BoE’s main interest rate should rise “relatively quickly towards a more neutral stance in order to prevent the recent trend of higher inflation expectations and rising pay growth from becoming more firmly embedded”.
The majority on the committee voted for a quarter-point increase to 1 per cent.
Saunders declined to give a clear definition of his view of the neutral interest rate, where the cost of borrowing neither stimulates economic activity or seeks to damp it. But he indicated it might lie in the range between 1.25 per cent and 2.5 per cent.
He noted that financial markets did not expect CPI inflation to fall back to 2 per cent if interest rates were in that range.
Instead of following BoE governor Andrew Bailey’s language of a “carefully calibrated” response to high inflation, Saunders preferred to highlight the risks of doing too little to stem inflationary pressure in the UK economy.
He noted that spending had held up well, companies expected to raise prices significantly in the months ahead and domestic prices of core services were rising almost twice as fast as the BoE’s 2 per cent inflation target.
The capacity of the UK economy to deal with high levels of spending was unfortunately more limited, Saunders added, with long-term sickness rates up sharply since the pandemic began as well as supply friction resulting from Brexit.
“We should lean strongly against the . . . risk [of inflation being persistently too high], because if it materialises — not a negligible risk, in my view — then the process of re-anchoring price expectations [to the 2 per cent inflation target] could be very costly in economic terms,” Saunders said.
If the economy performed worse and inflationary pressures subsided, he said the MPC “could reassess” the stance of monetary policy quickly.
The most likely cause of interest rates rising into a zone where policymakers actively sought to cut spending and raise unemployment would be if the BoE took too little action now. In these circumstances it would be duty-bound to squeeze inflation out of the economy later, Saunders said.
“I’d much rather not be in that scenario”, he added.
Saunders’ hawkish comments came as Andy Haldane, the former BoE chief economist, who now runs the Royal Society for Arts, took to the airwaves to criticise his former colleagues for acting too slowly to tackle inflation.
“This [inflationary period] won’t be come and gone in a matter of months. I think this could be years rather than months,” Haldane told LBC radio on Monday, adding that the inflation outlook was “getting on” to the levels seen in the 1970s.
Haldane added: “Now, to be clear, no amount of earlier squeezing on the brake would have fully prevented the cost of living crisis we’re getting. That is with us anyway, but do I wish we’d done a little bit more a little bit sooner, to tighten things up.”