Interest rates need to stay higher for longer, says Bank of England policymaker
Cuts in UK interest rates should be “a way off”, according to a Bank of England policymaker, who has said that inflationary pressures will keep the cost of borrowing higher than financial markets expect.
Megan Greene, a member of the Bank’s nine-member monetary policy committee (MPC), which sets interest rates, said financial markets were betting “in the wrong direction” when they judged how quickly the central bank would make its first rate cut.
A bigger-than-expected increase in US inflation in March to 3.5% surprised markets on Wednesday, pushing back expectations for the first Federal Reserve rate cut to September.
Greene said the markets expected the Fed and the Bank of England to reduce interest rates in tandem when the dynamics of the two economies were very different.
Financial markets are betting that the first reduction in UK interest rates from 5.25% will be in August and that there will be at least one further cut this year.
The consumer prices index measure of inflation has fallen steeply in recent months, to 3.4%, raising the prospect that it could drop below the Bank of England target of 2% as early as May.
Many independent economists believe inflationary pressures have reduced significantly, and recent jobs data shows the labour market has weakened, easing the pressure on employers to increase wages and the prices charged to customers.
The Bank’s governor, Andrew Bailey, has talked openly about the prospect of rate cuts this year, describing expectations for this as “not unreasonable”.
However, Greene, an American economist who joined the MPC in July, said the underlying causes of inflation in the UK remained persistent and would persuade the central bank to keep rates higher for longer than expected.
Writing in the Financial Times, she said: “There has been encouraging news on UK wage growth and services inflation in recent months. The risk of inflation persistence is diminishing as these indicators come down in line with the MPC’s forecast. But they remain higher than in other advanced economies, particularly the US.
“Momentum in the markets has been towards pricing in later rate cuts by the Fed as economic growth remains robust. In my view, rate cuts in the UK should still be a way off as well.”
US inflation fell sharply last year in response to falling energy prices, before rising again in recent months as the economy improved.
Greene said: “Following surprisingly strong US March consumer prices index inflation, markets now expect the Bank of England will cut rates earlier and by more than the Federal Reserve this year. The markets are moving rate cut bets in the wrong direction.”
She said the UK was struggling to escape the inflationary cycle, where second-round effects meant higher prices were feeding into higher wage demands. “I’m worried that secondround effects are having a larger and longer-lasting impact in the UK.”
The difference in labour supply between the two countries was stark and UK services inflation remained much higher than in the US, she said, adding: “Overall labour market participation in the UK has not recovered to the prepandemic trend. Participation in the US, on the other hand, has exceeded the pre-Covid trend.”
The next policy decision by the MPC is due on 9 May.