Bank of England (BoE) Chief Economist Huw Pill urged caution on cutting interest rates “too far or too fast” as he told ICAEW Annual Conference delegates that he was one of the four ‘dissenters’ of the rate-setting Monetary Policy Committee (MPC) who voted to hold rates in August.

The MPC voted by a majority of five to four to reduce the bank rate by 0.25 percentage points, to 5%, in August. The rate was held at 5% in September against expectations of a cut. 

The chief economist said there was still “ample reason for caution” in regard to inflation, despite the external shocks of the pandemic and invasions fading because there may be new disturbances to the global and UK economies.

While further cuts in the bank rate “remain in prospect”, he said, “It will be important to guard against the risk of cutting rates either too far or too fast. For me, this need for caution points to a gradual withdrawal of monetary policy restriction.”

Cross-checking

Speaking at ICAEW’s Annual Conference on 4 October, Pill said that rather than relying solely on a single baseline inflation forecast for his final policy vote, he found it helpful to employ other models to “cross check the assessments and implications” of the best baseline forecast. This approach places greater emphasis on discretionary add-ons allowing behaviours to be judged, as well as technical assumptions.

He said it wasn’t “the nature of the cross-checking exercise to offer definitive results”, but rather “to offer independent challenge to the baseline”. 

“Cross checking points to risks and concerns that are not captured by the baseline framework, and yet are relevant when we choose to seek these robust monetary policy decisions,” he said.

Households and businesses were keen to see a further fall in interest rates in the run-up to Christmas, and it is possible the MPC may cut rates one more time before the end of 2024. But Pill said that with some data pointing to deeper structural changes in the economy, the UK may require higher interest rates at some point to maintain the inflation target in a “lasting and sustained manner”. 

“Yes, the bank rate will need to fall over time, but at a pace that ensures sufficient restriction is maintained in the system during the transition for UK inflation to reach target in this lasting and sustained manner, not just fleetingly or in passing,” Pill said.

He said he remained “concerned about the possibility of structural changes sustaining more lasting inflation pressures”, but “a self-sustained virtuous cycle of declining headline inflation” relies on the maintenance of a “restrictive monetary policy stance to bear down on inflationary pressures”.

Pill said it was good news that headline consumer price inflation had returned to the BoE’s target of 2% earlier this year and is now looking to settle at around 2.5% by Christmas. 

But inflation in services prices had proved “stickier, stubbornly remaining at elevated rates, rates higher than those consistent with the achievement of price stability in the past”. The MPC views services, inflation and pay growth as more indicative of underlying inflation persistence. 

“The MPC has an important role to play. It’s by achieving its mandate to secure price stability that monetary policy provides a sound basis for the longer term investments and spending decisions by firms and by households on which innovation, dynamism and productivity growth in the UK rely,” Pill told delegates.

“The MPC cannot and will not be satisfied with a fleeting achievement of the 2% inflation target that lasts just a few months,” he said.

Pill said that as the impact of the significant external disturbances fades, “now is a good time for all of us to take stock and to look forward” in building an economy fit for the future.