Interest rates may have to rise more quickly and further than markets think to keep inflation under control, Mark Carney and his Bank of England colleagues have indicated.
Domestic price pressures – the type which the Monetary Policy Committee tries to control – are increasing and wage growth is making a reappearance, leading the Bank to increase borrowing costs.
However there is still ground to make up as real wages are also now 3.5pc below the level the Bank forecast in May 2016, in large part because of the weaker pound.
A key risk is that the Bank will be too slow to hike rates, said chief economist Andy Haldane, leading to an economic crash in future.
“Historically the thing which has killed jobs has been central banks stepping on the brakes too late,” Mr Haldane told the Treasury Select Committee.
“As [former Federal Reserve chair] Janet Yellen says, recoveries don’t die of old age, they die because central banks step on them, because they react too late. We’re absolutely clear, we don’t want to go back there again because it is bad news for jobs.
“That means going in this limited and gradual way to head things off in advance to prevent having to step on brakes, do a handbrake turn at a later stage.”
Mr Carney said the revival of domestic inflationary pressures means the Bank has to carefully raise rates over the coming years.
Imported inflation “will be with us for a few more years yet”.
“We are probably at the peak of it now, in terms of the pass through from imported inflation,” he said.
“Domestic inflationary pressures are beginning to firm, but they are firming from quite a low level. So the task for MPC, as those imported inflationary pressures come off, is to bring inflation back to [the Bank's 2pc] target in reasonable horizon.”
Although this means hiking rates soon – markets anticipate one rate rise in May or August, followed by another two rises over the next three years – policymakers are still keen to stress that rates will remain low relative to historical standards, even if borrowing costs are higher than they have been in recent years.
“We continue to talk about limited rate increases at a gradual pace – this is not a return to long run average of Bank rate of around 5pc, we don’t think that is necessary for the economy,” said Mr Carney.
Although wage pressures are growing, earnings are still being oustripped by prices, with inflation driven by the fall in the pound through 2016.
Mr Carney compared the pre-referendum forecasts to the current situation, and said real incomes are now 3.5pc below their expected level.
Although inflation should slide this year and wages pick up, the gap with that previously anticipated position will widen further.
By the end of this year real wages will be 5pc below the level anticipated by the May 2016 forecast, he told MPs.
MPC member Silvana Tenreyro said “depreciations make people poorer”.
However, Mr Haldane said it is also contributing to a rebalancing of the British economy.
“The combination of the weakening of the pound and the strengthening of the world economy has worked its magic,” he said.
“That has meant net trade has been a significant contributor [to GDP growth], and we expect those effects to continue over the course of the next two or three years – that has been part of this rather healthy rotation towards more net trade and somewhat less consumption than would have been the case before the referendum.”
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