MONETARY Policy Committee hawk Michael Saunders yesterday highlighted the value of flagging to households and businesses that interest rates are unlikely to go back up to pre-financial crisis levels in coming years, to help avoid “over-reaction” to increases.
But Mr Saunders, one of two members of the Bank of England committee to vote unsuccessfully for an immediate quarter-point rise in UK base rates last month, emphasised his view that the anticipated “gradual” pace of increases did not mean “glacial”.
Read More: Analysis: Saunders right to cite danger of over-reaction to interest-rate rises
Mr Saunders, who was visiting the University of Strathclyde’s Fraser of Allander Institute in Glasgow, highlighted Brexit as the “biggest uncertainty”.
Asked what gave him the greatest cause for concern, he replied: “The biggest uncertainty is Brexit and the effects that could have on the economy.”
He cited an indication from business surveys that “Brexit is a modest negative for the economy over time but that the adjustment is gradual”.
On interest rates, Mr Saunders, who was joined last month by fellow external MPC member Ian McCafferty in his vote for a rate rise, appeared to strike a notably more hawkish tone than that adopted by Bank of England Governor Mark Carney this week.
Mr Carney, in an interview with the BBC on Thursday, said: “We have had some mixed data ... We’ll sit down calmly and look at it all in the round…
“I am sure there will be some differences of view but it is a view we will take in early May [at the next MPC meeting], conscious that there are other meetings over the course of this year.”
On the subject of future interest-rate rises, Mr Saunders said “any further tightening is likely to be at a gradual pace and to a limited extent”, but added: “The key point is that gradual does not mean glacial.”
However, he also emphasised base rates were unlikely to return to pre-crisis levels in coming years. He cited estimates that the “neutral” rate, which appeared
to have fallen markedly in
the UK and other advanced
economies since the financial crisis, might be around 2% in the next few years, although he said he did not wish to endorse these too strongly.
Base rates are currently at 0.5%, having been raised by a quarter-point from their record low of 0.25% in November in what was the first rise in more than a decade.
Mr Saunders said: “It seems highly likely our policy rate in coming years will remain well below that pre-crisis average of five per cent.”
He added: “It seems useful for the MPC to convey that message [of] a lower neutral rate to households and businesses…in order to reduce risks of an over-reaction in demand that might occur if people wrongly interpret any rise in interest rates as a sign that rates are heading back to pre-crisis norms.”
Mr Saunders said it seemed likely that the neutral interest rate itself would gradually rise somewhat over time, while remaining well below pre-crisis norms.
However, he gave his view that, with structural estimates of the output gap probably more uncertain than usual, the MPC did not at present need to move too quickly to a neutral stance.
And he cited an argument for gradualism given the economy’s response to changes in interest rates, especially rises, was more uncertain than usual.
Mr Saunders said he had voted for a rate rise in March because, with spare capacity in the economy largely used up and cost pressures rising, he believed the economy no longer needed as much stimulus as previously.
He added: “Our foot no longer needs to be so firmly on the accelerator.”
Asked for his view on what could create a need for sharper rises in interest rates, Mr Saunders flagged as an example a scenario in which pay growth accelerated to 5% to 6%. He added that, unless this was accompanied by a marked pick-up in productivity, it would suggest the economy was overheating and the need to get back to a neutral rate would be much more urgent.
However, he emphasised: “That is not a scenario I expect to happen.”
Mr Saunders highlighted a view that the 1.2% month-on-month drop in UK retail sales volumes in March, revealed in seasonally adjusted figures published by the Office for National Statistics on Thursday, was to be expected given unusually heavy snow last month.
The ‘Beast from the East’ weather system brought heavy snow and freezing temperatures to the UK in late February and early March.
Read More: Retail sales plunge more than feared
Asked if there had been anything in the economic data since the MPC’s March meeting which would make him think twice about voting for a rate rise, Mr Saunders replied: “My take, not necessarily the committee’s take, is that the drop in retail sales is sort of what you would expect given the snow. The pick-up in average earnings was pretty much what you would have expected.”
Noting UK unemployment was at a 43-year low, Mr Saunders said the medium-term inflation outlook was driven mainly by domestic cost and capacity pressures, and these were gradually building.
He added that it was likely the labour market would tighten further, with unemployment edging down to new record lows.
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