Interest rates may have to rise to 2% or higher in the next year to rein in rocketing inflation and it is better to take aggressive action now than “too little too late”, according to a Bank of England policymaker.
Outgoing Monetary Policy Committee (MPC) member Michael Saunders – who has been recently outvoted in calling for a bigger hike in rates – said increases “still have some way to go” in order to get inflation under control.
In a speech at the Resolution Foundation think tank, he warned that, despite signs of a slowdown in the wider economy amid the cost-of-living crisis, the risks of not raising rates steeply and quickly outweighed those of being too cautious.
Interest rates have been raised to 1.25% from 0.1% since last December, but Mr Saunders voted for an increase to 1.5% at the meeting in June and has called for a 0.5 percentage point rise in rates at each of the last two MPC decisions.
He said: “The MPC has to balance the risks and costs of tightening ‘too much, too soon’ versus ‘too little, too late’. In my view, the cost of the second outcome – not tightening promptly enough – would be relatively high at present.
“Conversely, if the Committee tightens ‘too much, too soon’ and then finds the economy and inflation pressures are much weaker than expected, the policy outlook could adjust (if needed) and inflation expectations would probably be better anchored than now.”
He said expectations that rates will need to rise to 2% or beyond are not unrealistic, with inflation already at 9.1% and set to soar past 11% later this year.
“Without wishing to endorse those views too strongly, I do not regard such an outcome – ie that Bank Rate will have to rise to 2% or higher during the next year to return inflation to target – as implausible or unlikely,” he said.
“But, rather than focus on a precise forecast for Bank Rate over the next year, the key point is that the tightening cycle may (in my view) still have some way to go.”
Mr Saunders, who leaves after the next rates decision in August, said he believed the economy could withstand aggressive rate hikes.
He said: “There are signs that economic activity is slowing, as rising inflation erodes real incomes and spending.
“But this slowdown must be gauged against the backdrop that the economy early this year was in excess demand, potential growth is low, recruitment difficulties are elevated, and there is a sizeable backlog of unmet labour demand.
“Moreover, since the May MPR (Monetary Policy Report) forecast, the Government has announced further fiscal support measures.”
He said: “It is especially important at present to lean against risks that recent trends in inflation expectations, underlying pay growth and firms’ pricing strategies become more firmly embedded.”
Mr Saunders will be replaced on the Bank’s nine-strong MPC by Swati Dhingra of the London School of Economics, who joins next month.