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Big interest rate increases coming – BoE chief economist

Huw Pill

Bank of England Chief Economist Huw Pill signalled interest rates are likely to rise sharply in November to fight inflation and respond to the fiscal stimulus coming from the government.

He said the huge tax cuts and energy subsidies promised Prime Minister Liz Truss’s new government would probably boost the economy, echoing remarks made by BOE Deputy Governor Dave Ramsden last week.

He added that it’s too early for the central bank to “declare victory” on holding expectations about future price increases to its 2% target.

The remarks are the latest to underscore the likelihood that borrowing costs will keep rising as the UK struggles to contain inflation, which is near its highest level in 40 years and set to climb back into double digits.

The BOE has raised interest rates seven times in succession since December. Investors are pricing in a hike of at least 1 percentage point next month — the biggest rise since 1989 — and see the benchmark rate approaching 6% by May, from the current 2.25%.

The Monetary Policy Committee is scheduled to give its next interest rate decision on Nov. 3, days after Chancellor Kwasi Kwarteng delivers his medium-fiscal term fiscal strategy. The Treasury event was brought forward by more than three weeks after his £43 billion ($48 billion) package of unfunded tax cuts triggered market panic.

The announcement may potentially reduce the inflationary impact, with Kwarteng under pressure to cut spending or reverse some of his tax reductions to calm investors worried that the government risks losing control over the public finances.

Those fears have sent UK assets tumbling and forced the BOE to step in with emergency government bond purchases to prevent a meltdown in the pensions industry. With the pound falling below $1.10 at one point on Wednesday and the yield on 30-year gilts climbing to 5%, Governor Andrew Bailey is facing calls not to end the program on Friday as planned.

“I didn’t see the governor’s statement last night,” Pill said in response to questions after his speech. “The bank has made a statement this morning. That statement, the governor’s statement and our original statement about two weeks ago have all been consistent in saying that these operations were going to end on the 14th.”

Pill’s text didn’t dwell on the market turmoil and instead focused his remarks on the reasons policymakers see pointing to higher rates.

“Given the uncertain world and volatile markets we face, November can seem a long time away,” he said in the text of a speech released as he spoke in Glasgow on Tuesday. “At present, I am still inclined to believe that a significant monetary policy response will be required to the significant macro and market news of the past few weeks.”

On the government’s economic plan, Pill said, “these fiscal announcements will, on balance, provide a further stimulus to demand relative to supply over the medium-term” and that “this will add to the inflationary pressure.”

Credibility Crucial

He said it’s crucial for the BOE to stick to its mandate on inflation to maintain the credibility of the UK’s economic framework, noting that the Treasury’s growth program set out in September was the trigger for the latest chaos in markets.

“The volatile market dynamics that followed the announcement of the Growth Plan underline the need to bolster the credibility of the wider institutional framework,” Pill said.

“Whether reflecting pressures from the fiscal, financial or other domains, it is essential that the credibility, stability and integrity of the institutional framework governing UK macroeconomic policies are maintained.”

He welcomed the fact the Oct. 31 fiscal statement will be accompanied by an assessment from the non-partisan Office for Budget Responsibility, whose sidelining when the tax cuts were first announced contributed to the adverse market reaction.

Questions Answered

Answering questions after the speech, Pill rejected suggestions that the UK would drift into the same sort of economic stagnation and inflationary spiral that hit in the 1970s.

“I don’t think we’re headed for stagflation,” Pill said. “We have a very different institutional framework now. It’s the change in the institutional framework that rules out the reemergence of that stagflationary environment.”

He said the BOE’s tools are meant to act on inflation in the medium term, not to deal with monthly fluctuations.

“What we’re seeing is that the BOE also has a responsibility towards market stability — we’ve seen that recently,” he said. “That’s where we need to be much more agile. Ultimately our credibility has to stem from what we can control. We’ve been unlucky to see this series of inflationary shocks that’s put us under pressure.”

On the recent weakness in the pound, Pill said BOE officials couldn’t be “indifferent” but wasn’t focused on the foreign exchange market.

“The exchange rate is important in so much as it’s influencing the medium-term inflation outlook,” Pill said.

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