InvestmentsJun 13 2019

UK economy growing at 'maximum rate'

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UK economy growing at 'maximum rate'
ByDavid Thorpe

Michael Saunders, who is a member of the interest rate setting committee at the Bank of England, believes the economy is growing at the maximum pace it can right now.

Speaking at Solent University on 10 June Mr Saunders said the UK economy had reached "zero output gap" and if it is growing at between 0.4 and 0.5 per cent per quarter "that is a modest pace by historical standards but slightly above the economy’s reduced level of potential".

"Zero output gap" is a term economists use to describe an economy that is operating at the full level of potential.

Mr Saunders pointed to the low unemployment rate in the UK and the low savings rate as reasons for his view that the economy won't be growing any faster.

Mr Saunders' colleague at the Bank of England, Andy Haldane, has previously said the UK’s potential growth rate has fallen in recent years from about 2 per cent to 1.5 per cent as a result of anticipated lower migration as a result of Brexit.

The potential growth rate, or trend rate as economists call it, comprises productivity growth plus population growth over the longer term. Growth above or below this level should be temporary, and is the result of government or central bank policies.

The main challenge for central bankers such as Mr Saunders is that if the economy grows at above its potential growth rate, then the extra growth converts quickly to inflation, which creates asset bubbles in the economy and could lead to a crash.

This is why central banks lift interest rates when economic growth is strong. Mr Haldane has said that it is always better to put rates up and risk a slowdown in the economy that is short-term, rather than risk rates being too low and a much more severe crisis occurring.  

Mr Saunders' view is that if there is an orderly exit from the European Union then interest rates in the UK will need to rise, as the economy is already at its full potential, and the removal of Brexit related uncertainty will push growth above its potential level and so generate inflation, and necessitate an interest rate rise.

Mr Saunders added that the slower pace of economic growth in the UK in recent months was mostly the result of lower demand for exports due to a slowdown in global growth, but he expects this to dissipate in the new year.

He said: "Growth rises a little above trend from early 2020, pushing the economy into significant excess demand, with the result that inflation is forecast to be above the 2 per cent target and rising 2-3 years ahead.