Bank of England Chief Economist warns against cutting interest rates too much

The Bank of England chief economist stated that interest rates should fall slowly and remain higher in the long term to combat stubborn inflation. This suggests a growing disagreement among central bank rate-setters.

Huw Pill predicted that the UK economy would undergo a “virtuous circle” of stabilising the inflation rate over the next year. He added in a speech to the Institute of Chartered Accountants in England and Wales, however, that this dynamic relies on “maintaining a restrictive monetary policies stance in order to keep inflationary pressures in check”.

He continued: “Bank rates will need to drop over time, but at a rate that ensures enough restriction is maintained during the transition to allow UK inflation to achieve target in a sustained and lasting manner, not only briefly or in passing.”

He warned that “deeper structural change in the UK’s economy could lead to a longer-lasting inflationary dynamic”. This would require “an equally long-lasting monetary policy to bring inflation back to target and maintain it there”.

He said that the Bank of England’s assumption of neutral interest rate levels, which do not restrict growth nor ignite inflation, is too low.

The comments contradict comments made by Andrew Bailey to The Guardian, in which he suggested that the rate-setting committee of the central bank could be “a bit more aggressive” with its policy if inflation continues to decline.

Bailey’s remarks led to one of the largest falls in the pound against the dollar in a single day since the mini-budget of Liz Truss in September 2022. Bailey’s remarks led to the pound experiencing one of the largest one-day drops against the dollar, since it reached a record-low in the wake of Liz Truss’s mini-budget of September 2022. Sterling strengthened 0.26 percent after Pill’s comments to $1.3157 before reversing its gains in the wake of a strong US labour market report. The pound gained 0.55 percent against the euro, reaching €1.196.

Pill stated that he was “concerned” about structural changes creating more long-lasting inflationary pressures. The Bank of England has set a target of 2 percent for inflation.

Since the Bank of England became independent in 1992, the views of its chief economist and governor, which are rarely different, have been used as a guide to what the monetary committee (MPC), the body that sets interest rates, will do. The MPC will face a tight race in the coming months due to differing opinions about inflation persistence and borrowing costs. Bailey voted for a 25-basis point reduction in borrowing costs at the August meeting. This was the first cut since March 2020. Pill voted against the reduction, with a vote of 5-4. Both agreed to keep rates the same at the September meeting.

The meeting minutes show that despite the 8-1 vote in favor of keeping rates, the MPC had a range of opinions about the inflation’s stubbornness. Some members of the committee are concerned that wages and service prices are too high. Pill also reiterated this concern in his ICAEW address. Others are not convinced by the possibility of inflation going above the 2% target.

Following Bailey’s remarks on Thursday, traders in the financial markets expect the MPC will lower rates by one quarter point during both November and December meetings. This would bring them down from 5% to 4.5 percent.

RBC Capital Markets analysts believe that the MPC may loosen its policy each time it meets between November and May.