Interest rates could top 2% in the coming year as the Bank of England acts to prevent high inflation from taking hold of the economy, one of its policymakers has said.
Michael Saunders, who is leaving Threadneedle Street’s Monetary Policy Committee (MPC) next month, said he backed tougher policy because the risks of doing ‘too little, too late’ outweighed the risks of doing “too much, too soon”.
In a farewell speech to the Resolution Foundation think tank, Saunders said further increases in official borrowing costs were needed even though the economy had slowed in recent months.
Economist polls and financial market sentiment suggest UK interest rates are on course to rise from their current level of 1.25% to 2% or even higher in the coming year, Saunders said. .
“I don’t consider such an outcome to be implausible or improbable,” he added.
Saunders was one of three members of the Bank’s nine-member MPC who voted for a half-point hike when interest rates rose from 1% to 1.25% last month .
With annual inflation expected to approach 10% when the latest cost of living figures are released later this week, another interest rate hike is expected at the MPC meeting in August.
Saunders said a series of negative shocks – including Brexit, the Covid-19 pandemic and soaring energy prices – had reduced the rate at which the economy could grow without generating higher inflation.
“The deterioration in potential output over the past few years means capacity pressures are widespread even with GDP slightly above pre-pandemic levels,” he said.
There were signs of slowing economic activity, as rising prices eroded living standards, the MPC member added. “But this slowdown must be measured against the backdrop of the economy at the start of the year being in excess demand, potential growth is low, recruitment challenges are high and there is a significant backlog of labor demand. unsatisfied work,” he said.
“Furthermore, since the May monetary policy report forecast, the government has announced further fiscal support measures.”
Saunders said he believed another interest rate hike was likely and signaled he would vote for a half-point hike again next month.
“In broad terms, the MPC must 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 fast enough – would be relatively high right now.
“With excess demand and high inflation, ‘too little, too late’ would increase the likelihood that recent trends in underlying wage growth, longer-term inflation expectations and commodity pricing strategies businesses become more firmly entrenched,” Saunders said.