Interest rates could rise above 2% next year as the Bank of England acts to prevent high inflation from taking root in the economy, one of its policymakers said.
Michael Saunders, who is leaving Threadneedle Street’s monetary policy committee (MPC) next month, said he supported tighter policies because the risks of doing “too little, too late” outweighed the risks of doing “too much, too early”.
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 surveys and financial market sentiment show that UK interest rates are on track to rise from their current level of 1.25% to 2% or even more next year, Saunders said.
“I do not consider such an outcome implausible or unlikely,” he added.
Saunders was one of three members of the bank’s nine-member MPC to vote for a half-point increase when interest rates were raised from 1% to 1.25% last month.
With the annual rate of inflation expected to approach 10% when the latest cost of living data is released later this week, a further rate hike is expected at the MPC’s August meeting.
Saunders said a series of negative shocks – including Brexit, the Covid-19 pandemic and spiraling energy prices – had reduced the rate at which the economy could grow without generating higher inflation.
“The deterioration of potential output in recent years means capacity pressures are widespread even with GDP only slightly above pre-pandemic levels,” he said.
There are signs that economic activity is slowing as rising prices erode living standards, the MPC member added. “But this slowdown must be seen against the background that the economy was in overdrive at the start of this year, potential growth is low, recruitment difficulties are elevated and there is a significant backlog of unsatisfied labor demand,” he said. .
“Furthermore, following the May Monetary Policy Report forecast, the government announced additional fiscal support measures.”
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Saunders said his view was that further rate hikes were likely and signaled he would again vote for a half-point increase next month.
“Broadly speaking, the MPC must balance the risks and costs of tightening ‘too much, too soon’ against ‘too little, too late.’ In my opinion, the cost of the second result – if they don’t tighten up fast enough – would be relatively high right now.
“With excess demand and elevated inflation, ‘too little too late’ will increase the likelihood that recent trends in underlying wage growth, long-term inflation expectations and firms’ pricing strategies will become more firmly embedded,” Saunders said.
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