A supporter of raising UK interest rates has argued a gradual increase now helps provide “insurance” should policymakers need to respond to a “bumpy” Brexit.
Michael Saunders is one of two current members of the Bank of England’s monetary policy committee (MPC), which sets the rate, to have voted in favour of raising borrowing costs.
In a speech in Cardiff, the economist explained his view that the Bank should opt for a “modest” increase.
He argued such a move would provide some wriggle room to respond to potential shocks ahead and help smooth the path back to normality following the financial crisis.
Image: Michael Saunders joined the MPC in August 2016
He told the audience he felt the trade-off between maintaining ultra-loose support for the economy and tackling inflation had “shifted markedly” during 2017.
Interest rates have been held at a record low of 0.25% since August 2016 when the Bank cut its core interest rate amid fears the economy could fall into recession following the vote to leave the EU.
It also bolstered its wider stimulus measures such as quantitative easing – first made available to tackle the effects of the financial crisis.
Mr Saunders said it was time to return rates to their post-crisis level of 0.5% against a background of expectations that inflation would hit 3% by the end of the year – well above average wage growth – driven higher by the Brexit-linked collapse in sterling’s value which has resulted in a surge in import costs.
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The Bank of England’s target is 2%. It is currently standing at a rate of 2.6%.
In arguing for a gradual increase in interest rates to help limit inflation, he said such a move would be tolerable given high employment and the absorption of spare capacity in the economy.
He said: “We do not need to be putting the brakes on so much that the economy weakens sharply.
“But our foot no longer needs to be quite so firmly on the accelerator, in my view.
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“A modest rise in rates would help ensure a sustainable return of inflation to target over time.
“I do not want to dismiss risks that the Brexit process might be bumpy, and could undermine business and consumer confidence.
“In such a scenario, inward migration might also be lower, limiting labour supply and demand. I presume asset markets would also adjust, including sterling.
“The monetary policy implications of this scenario are not automatic, could in theory go either way, and would depend on the combined effects on demand, supply, and the exchange rate.
“In my view, we should not maintain an overly loose stance as insurance against this scenario. Rather, we should be prepared to respond as needed if it happens.”
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There was a shock for markets and economists in June when the MPC voted 5-3 in favour of raising rates.
The make-up of the committee has since changed but it brought home the idea that rates could rise sooner or later.
While rising rates would provide some relief to savers, who have seen the value of their holdings hit by rock-bottom rates, some economists fear increased borrowing costs risk choking weak economic growth with consumers facing higher mortgage repayments.
Mr Saunders’ comments failed to support sterling which fell against both the dollar and euro on Thursday as evidence mounted the Brexit negotiations were becoming mired in difficulty.
The pound was trading almost three tenths of a cent down against both.