BoE's Saunders says economy might have more spare capacity than thought

By Andy Bruce and William Schomberg

LONDON (Reuters) - Britain's economy may have more room to bounce back from the COVID-19 pandemic before it generates excess inflation than the Bank of England predicted last month, one of its policymakers said, signalling no rush to start reining back on stimulus.

Michael Saunders said the recovery from last year's 10% slump might be quicker than the BoE's central forecasts, made in early February. Those forecasts include a 5% recovery in 2021 as the country races ahead with coronavirus vaccinations.

But that did not automatically mean inflation pressure will surge too, the rate-setter said in a speech on Friday.

It was reasonable to think slack in Britain's economy - the output gap - was "much greater" than the BoE assumed last month, Saunders said, citing a rising jobless rate and surveys that show many companies are working below capacity.

"My hunch, taking account of a somewhat more optimistic assessment of the outlook for potential output, is that it will take longer to close the output gap than forecast," he said.

The risk posed by an incomplete recovery with a persistent output gap was greater than a scenario in which the gap closes quickly and generates inflation, Saunders said.

This meant that "risk management considerations" might be needed when weighing up how much stimulus the economy needs.

Saunders' comments put him broadly in the centre of the range of views among the nine members of the Monetary Policy Committee and contrast with those of Chief Economist Andy Haldane, who has warned of an inflation "tiger".

Saunders said the unemployment rate would be a good future benchmark in judging the extent to which the output gap is closing.

"In my view, a jobless rate of well above 5% (the February ... forecast for Q1-2022 was 5.7%) would almost certainly indicate that we are some way from closing the output gap sustainably," he said.

Officials are debating how the BoE might eventually unwind some of the stimulus it has pumped into the economy, first to offset the global financial crisis and more recently to tackle the COVID-19 pandemic.

Saunders said the BoE's record-low interest rates might not need to rise as high as 1.5% before the central bank starts to bring down the size of its 895 billion pound bond-buying scheme.

"There are arguments to set a slightly lower threshold on the grounds that ... a slightly negative policy rate will be in the toolkit, whereas it wasn't previously," he said in answer to an audience question.

(Reporting by William Schomberg and Andy Bruce; Editing by Catherine Evans)