BOE’s McCafferty Says Period of Loose Policy May Be Ending

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Bank of England policy maker Ian McCafferty said the U.K. economy will continue to recover and the time to begin policy tightening is approaching.

“The economy is starting to return to more normal conditions, after arguably the biggest shock in over a hundred years, and we expect this healing process to continue,” he said in a speech released Friday by the central bank. “As a result, the time of the extraordinary policy stance of recent years is gradually drawing to a close.”

McCafferty was one of two of the BOE’s nine policy makers who had been voting for an interest-rate increase in 2014 and then dropped their call as inflation slowed. While the rate was left at a record-low 0.5 percent this month, recent decisions have been “finely balanced” for two members.

The possibility that inflation slowing well below the bank’s target will dislodge expectations for consumer prices initially fed his view that risks were to the downside, he said. Now, signs of tightness in the labor market, including some pay pressures, are emerging.

“As the months pass, it is becoming clearer that the risk of a material de-anchoring of inflation expectations is diminishing,” he said. “As these downside risks diminish, and as the remaining spare capacity is absorbed over the next year or so, the balance of risks to the inflation outlook, for me, shifts gradually to the upside.”

“Accelerate Markedly”

He said there’s a risk that next year and in 2017, wage deals and average earnings “accelerate markedly,” and if there’s no accompanying improvement in productivity that pickup “would become inconsistent with maintaining inflation at 2 percent.”

Consumer prices fell on an annual basis in April for the first time in more than 40 years, though BOE Governor Mark Carney has forecast a pickup at the end of the year, and the Monetary Policy Committee sees inflation back at its 2 percent target within two years.

“While the period of ultra-low inflation is expected to persist for several more months, the near-term downside risks are diminishing,” McCafferty said. “Company and household inflation expectations have both fallen a little, but remain consistent with the inflation target, and a high proportion of households think that it is a good time to undertake large purchases.”

With the MPC facing an uncertain outlook for labor-cost pressure, inflation and productivity, McCafferty said “economic conundrums” remain.

“Should we expect the economy to return fully to the way it behaved pre-crisis? How will the economy respond to changes in the interest rate after such a long period at 0.5 percent?” he said. “The issues and uncertainties of how the economy will perform in the post-crisis world will continue to challenge the MPC and macro-economists more widely for some time to come.”