InvestmentsApr 20 2018

Bank’s Saunders on why interest rates have to rise

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Bank’s Saunders on why interest rates have to rise

A member of the Bank of England’s monetary policy committee (MPC) has revealed the reasons why he recently voted to put UK interest rates up.

Michael Saunders was of two members of the nine-member committee to vote in favour of an interest rate rise in March.

Speaking at the University of Strathclyde this morning (20 April), he said the bank has had to do a "trade-off" between the priorities of stimulating the economy at a time of economic uncertainty caused by the Brexit vote and dragging inflation back towards the target rate of 2 per cent.

He said that as the economy continued to grow, the need for the central bank to provide stimulus would weaken and greater priority could be given to the quest to push inflation down to 2 per cent.

Mr Saunders said: "My vote at the March meeting reflected a preference for an earlier tightening path than implied by the market curve. We do not need to set policy in a way that will create rising spare capacity or higher unemployment. But our foot no longer needs to be so firmly on the accelerator."

UK rates last went up in November 2017 to 0.50 per cent and the market is currently pricing in a UK interest rate rise in May.

But Bank of England governor Mark Carney, who is also a member of the committee, said interest rates may not rise soon due to the uncertainty around Brexit.

Mr Saunders's comments come in light of the International Monetary Fund (IMF) marginally upgrading its growth forecast for the UK economy in 2018 to 1.6 per cent.

Fund managers Neil Woodford and Richard Buxton both believe growth will be higher than that, at 2 per cent, while the Office for Budget Responsibility, the official body charged by the government providing a picture of the UK economy, estimated growth would be 1.5 per cent.

The most recent inflation number to emerge for the UK economy showed a drop to 2.5 per cent, from the previous level of 2.7 per cent.

Mr Saunders said he expected wages to continue to rise, ensuring inflation would remain high.

He said he expected economic growth to be between 1.5 and 2 per cent, and in such a climate, he said the economy would not need policies designed to encourage growth, such as low interest rates, but instead needed policies to make inflation fall, such as higher interest rates.

Higher interest rates push inflation downwards because they push the cost of borrowing, and often the cost of repaying existing debt, upwards, leaving less cash to spend. They also incentivise saving over spending.

Mr Saunders dismissed data which suggested the UK economy may have slowed a little in the first quarter of 2018.

He said: "The significance of this apparent slowdown is questionable. Economic activity in March, and especially retail sales, was hit by unusually heavy snow. Previous experience suggests that such snow effects typically reverse in the next month or two."

Mr Saunders added that he expected UK rates to peak at a much lower level in future than they have been at previous peaks.

david.thorpe@ft.com