Friday 21 October 2016

Bank of England official warns interest rates must be hiked sooner than later

Szu Ping Chan

Published 17/08/2015 | 09:15

The Bank of England could damage Britain's recovery if officials wait too long before starting to raise interest rates, one of its policymakers has warned.

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Kristin Forbes said keeping rates at a record low of 0.5pc when the economy was growing at its pre-crisis trend and earnings were rising at a robust pace risked “creating distortions” and “undermining the recovery”.

Comparing the Bank’s job of keeping a lid on inflation to preventing sunburn, Ms Forbes cautioned that it can take up to two years for rate rises by the Bank’s monetary policy committee (MPC) to filter through to the economy.

The MIT professor, who is one of the nine members of the MPC that sets interest rates, said that China's recent decision to devalue the renminbi along with recent falls in energy and commodity prices meant the MPC had a “bit more time before inflationary pressures build in the UK”.

However, in a series of hawkish observations, she cautioned that the temporary forces currently pushing down on inflation could “burn off quickly”.

Writing in the Telegraph, she said: “With such low inflation today, it is understandable to want to avoid pre-emptively ending this holiday. A solid recovery is finally here. Increasing interest rates prematurely could moderate companies’ willingness to invest and consumers’ willingness to spend. But unfortunately monetary policy works with lags.

“Maintaining interest rates at the current low levels during an expansion risks creating distortions. Therefore, interest rates will need to be increased well before inflation hits our 2pc target. Waiting too long would risk undermining the recovery—especially if interest rates then need to be increased faster than the gradual path which we expect.”

UK Inflation, as measured by the consumer prices index (CPI) is expected to remain close to zero in the coming months, before rising to around 1pc early next year.

Ms Forbes said she would monitor measures of core inflation, which strip out volatile elements such as food and energy, closely for signs of stronger domestic price pressures.

“The appropriate time [to raise rates] will depend critically on when there is more evidence that inflation is heading towards target as forecast,” she said.

Ms Forbes also said the strength of the pound, which has climbed by 3.5pc against a basket of common currencies between May and August alone, was also likely to push down on inflation.

However, she said recent evidence suggested the pound’s appreciation from early 2013 through mid-2014 “did not reduce import prices by as much as has historically occurred, thereby causing less drag to inflation.”

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