Negative rates may be BoE's best tool in future - Saunders

By David Milliken and William Schomberg

LONDON (Reuters) - Bank of England policymaker Michael Saunders said negative interest rates may soon be the best tool for the BoE, and raised the prospect of unemployment taking a long time to return to pre-pandemic levels.

Earlier this month the BoE gave British banks six months to prepare for any decision to cut rates below zero - which economists currently view as a distant prospect given the likelihood of a rapid recovery in the second half of 2021.

Saunders, one of nine members of the BoE's Monetary Policy Committee, said in December that he saw scope for borrowing costs modestly below zero. On Thursday he said negative rates could become the BoE's preferred tool in certain circumstances.

"If we wanted to lower the yield curve from current levels, then I suspect a lower Bank Rate might be more appropriate," he told the Resolution Foundation think tank.

BoE Deputy Governor Dave Ramsden said on Wednesday that bond purchases remained his preferred option if the economy needed more help.

Saunders said more bond-buying could be the right choice if the BoE faced market turmoil like at the start of the pandemic in March. Changes to its Term Funding Scheme for banks would be the best approach if small businesses faced credit issues.

Britain is rolling out COVID vaccines faster than other European countries, bring the prospect of a lifting of most COVID restrictions. Economists say inflation will exceed the BoE's 2% target later this year due to temporary factors.

However, Saunders - who has previously expressed caution about the recovery - said weakness in the labour market risked putting long-term downward pressure on inflation.

Official unemployment in Britain was 5.0% in the three months to November, and the BoE expects it to rise towards 8% if the government's job support measures expire as planned at the end of April.

Before the crisis, unemployment was below 4%, its lowest since the mid-1970s.

"The kind of unemployment rates that we had in the pre-pandemic period are what we should have as a guide to get back to," Saunders said. "As long as unemployment is above those levels, we should think of the recovery as incomplete."

The BoE forecasts the economy will return to its pre-crisis size by early next year - sooner than most economists expect - but that unemployment will take years longer to return to pre-crisis levels.

(Reporting by David Milliken; Writing by William Schomberg)