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BOE Official Tells Hawks That Rates Are Too High for Economy to Withstand
(Bloomberg) -- Bank of England policy maker Silvana Tenreyro compared her hawkish colleagues to a “fool in the shower” who scalds himself by being too impatient to wait for the water to warm up, saying interest rates are already too high for the economy to bear.
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Tenreyro said rates have been raised too far and inflation will fall below the 2% target in the medium term as a result.
Tenreyro is the chief dove on the BOE’s nine-member Monetary Policy Committee but has just two meetings before her term expires. Her final votes in May and June will be crucial as officials consider whether to pause their most aggressive hiking cycle in four decades.
The BOE has voted to lift its key lending rate 11 times running to 4.25% and markets are betting it pushes ahead with an increase to 4.5% on May 11 after a slew of surprisingly strong wage and inflation data this week.
In her opening remarks at the National Bureau of Economic Research’s annual conference on macroeconomics in the US, Tenreyro said it was the BOE’s job to set rates based on what will happen in the future, not what is happening right now.
Rates, she said, have already been raised more than enough and officials should now wait for the impact to come through.
“The shape of the inflationary shock stemming mostly from the large increase in energy prices, coupled with the long lags with which monetary policy affects the economy, means that the most likely scenario now is that we undershoot the inflation target in the medium term, meaning 2025,” Tenreyro said.
Those who want to keep raising rates she likened to Milton Friedman’s “fool in the shower.”
“When the fool starts the water and it runs cold, he keeps turning the faucet and, eventually, because he’s impatient, he gets burned,” she said.
She said high energy prices have hurt incomes and made the UK poorer, and warned against comparing the UK’s experience with the US. As a net exporter, the US has been enriched by the energy crisis. Policy in the UK therefore needs to respond differently.
Consumption has fully recovered to pre-pandemic trends in the US but remains below trend in the currency bloc and below pre-pandemic levels in the UK, which has been hardest hit of all, Tenreyro demonstrated.
“In the UK, the shape of the inflationary shock stemming mostly from the large increase in energy prices, coupled with the long lags with which monetary policy affects the economy, means that the most likely scenario now is that we undershoot the inflation target in the medium term, meaning 2025,” she said.
“Given policy lags, policy needs to be based on forward looking forecasts and those forecasts at least for the UK are telling us that we may already have tightened too much.”
She said the BOE’s mandate to keep inflation to 2% is flexible enough to respond to shocks, that policy makers should focus on hitting the goal at the end of the forecast horizon.
“We are by mandate not strict inflation targeters,” she said. “We are flexible inflation targeters. We are not intended to keep inflation at 2% whatever the circumstances. We need to always focus on the medium term.”
“It’s about hitting inflation targets at the horizon in which monetary policy can act,” she said.
On quantitative tightening, she said:
“We are using the bank rate as the marginal instrument” of monetary policy. “So we can see directly the effect the effects of any QT on the market yield. We can adjust interest rates if there is too much or too little tightening coming from quantitative tightening.”
--With assistance from Tom Rees.
(Corrects spelling of name in second and 11th paragraphs and fixes typo in first paragraph.)
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