UK interest rates already higher than needed, says BoE policymaker

UK interest rates are already higher than they need to be to bring inflation back to its target level, a Bank of England policymaker argued on Friday.

Silvana Tenreyro, an external member of the BoE’s Monetary Policy Committee, told a conference in London that “policy was already in restrictive territory” before the November MPC meeting, when the majority of members voted to raise interest rates by 0.75 percentage points to 3 per cent.

She said it was too early to see the full effects of “the fastest tightening in policy in the MPC’s history”, arguing that interest rate rises fed through to the economy more slowly than in the past, as fixed-rate mortgages were more common and most homeowners had yet to refinance.

Even if interest rates remained at their current level, the economy was likely to fall into recession and inflation to fall below target in the medium term, leading the BoE to cut interest rates from 2024, she suggested.

If interest rates rose in line with recent market expectations, the UK would face a prolonged recession accompanied by a sharp rise in unemployment and further falls in living standards.

UK GDP shrank in the third quarter, according to official data released on Friday that suggested the economy had already entered recession and was now smaller than immediately prior to the Covid-19 pandemic.

Other MPC members have already made clear that the central bank does not think interest rates will need to rise as high as the 5.25 per cent peak market pricing implied in the run-up to the last policy meeting.

But Tenreyro, who has been one of the most dovish voices on the MPC in recent months, is an outlier in suggesting that the central bank has already done enough to rein in inflation, which stood at 10.1 per cent in September — five times the BoE’s 2 per cent target.

Jonathan Haskel, another MPC external member, struck a very different note in a speech published on Friday, which he was due to deliver at the Bank of Israel on Sunday. Haskel said the latest signs of the economy slowing did not imply there was less need for the BoE to tighten policy.

High inflation could be especially sticky in the UK, he argued, because the country had a very tight labour market — partly as a result of ill health keeping people out of the workforce — and a very poor record on investment.

“My concern is that these supply-side stresses risk persistent inflationary pressure . . . right now, I believe it important for monetary policy to stand firm,” Haskel said.

But some observers are increasingly worried that central banks — having been too slow to raise interest rates in the recovery from the pandemic — could now make the opposite mistake, with their collective efforts to curb inflation causing a sharper global downturn than necessary.

Tenreyro dissented from the majority of MPC members at the last meeting, voting for a rate increase of just 0.25 percentage points. The only reason she backed even this increase, she told the Society of Professional Economists, was to guard against the risk of so-called “second-round effects” setting in and turning high inflation into a self-fulfilling phenomenon.

This could happen if people saw high inflation as normal, with workers demanding bigger wage rises to offset it and companies trying to preserve profit margins.

But, she said, there were now signs of the labour market loosening, with employers telling BoE agents that they had paused recruitment, and fiscal policy also looked likely to be “tighter than I previously assumed”.