U.K. Recovery Splits Central Bank Alumni on Rates
While the Monetary Policy Committee kept its benchmark rate at a record low today, speculation among forecasters is mounting that it is on the verge of a split. Echoing that debate, Andrew Sentance insists the panel should have started increasing borrowing costs already, while Sushil Wadhwani says it must wait as the economy uses up spare capacity.
“We should really have had the first rate rise by now,” Sentance, who sat on the rate-setting panel until 2011, said in an interview yesterday. “The danger is getting behind the curve. You would have to raise them more sharply than the MPC would ideally like, and deliver a bigger shock to the economy.”
After six quarters of expansion, officials are balancing the need to move away from emergency policy settings against below-target inflation and the weakest wage growth on record. As the MPC members diverge on how to interpret recent data, Carney will provide more insight into their thinking next week when he publishes the BOE’s new economic forecasts.
For Wadhwani, who left the MPC in 2002, uncertainty about how to unravel conflicting signals from the data means the current nine-member panel shouldn’t rush into anything.
“It pays to wait and at least see some tangible signs that wages are picking up,” he said. “If you raise rates prematurely and abort a recovery, the costs associated with that, having taken so long to establish one, are much higher than the costs of waiting just a little bit.”
The BOE kept the key rate at 0.5 percent after a meeting in London today, as forecast by all 47 economists in a Bloomberg News survey. The European Central Bank left its key rate unchanged at 0.15 percent today.
“With wages barely growing and the degree of slack in the labor market still looking uncertain the BOE is content to leave policy unchanged,” said James Knightley, an economist at ING Bank NV in London. “Given we don’t expect any significant loss of momentum for the U.K. economy over the rest of the year, we favor a November rate hike.”
While the BOE decision marked a 65th month of no change, it masks the intensifying policy discussion. Officials are having a “very deep debate” about wage growth and why their forecast for a pickup was wrong, Wadhwani said. Pay excluding bonuses is rising at the slowest pace in at least 13 years and inflation stayed below the 2 percent target for a sixth month in June.
Another former MPC member, Charles Goodhart, said today there are “a number of reasons” why it is not yet time to increase rates.
“Wages continue to surprise on the downside and we need to worry about that,” he said in an interview on Bloomberg Television. “The euro zone is beginning to look a bit worse again,” meaning a rate increase could boost the pound and “imbalance the economy,” he said.
At last month’s MPC meeting, some officials wanted to focus on weak wage data, while others said the risk of a rate increase derailing the expansion was “receding.”
Even as signs of divergence emerge, traders are betting it will take until March for a majority of policy makers to back an increase in rates. More details of the debate will come on Aug. 13, when Carney will present the new economic forecasts at a press conference, and a week later, when minutes will reveal how each member voted at today’s meeting.
Another consideration for the MPC will be how fast to tighten policy once it begins rate increases. Deputy Governor Ben Broadbent said in an interview last week that the scale of Britain’s household debts supports the case for “gradual and limited” moves, but not the argument for leaving borrowing costs at a record low.
“By leaving it as late as they have done, they are making it increasingly difficult to stay gradual,” said Philip Rush, an economist at Nomura International Plc in London. “They are trading that risk off against the risk that the economy isn’t resilient enough to withstand rate hikes.”
Record employment and continued economic growth may be enough to offset the arguments for emergency policy for some MPC members. A Markit Economics composite index of services, manufacturing and construction showed a 19th consecutive month of expansion in July, and the International Monetary Fund predicts GDP growth of 3.2 percent this year, which would be the fastest in the Group of Seven.
“Things are still pretty strong,” said Simon Wells, an economist at HSBC Securities Inc. in London and a former central bank official. “In the face of uncertainty, the question is whether they should be more worried about losing control of inflation or killing the recovery.”
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