UK interest rates may need to be cut this year as the pressure on households and businesses from high borrowing costs ripple through the economy, a senior Bank of England policymaker has said.
Silvana Tenreyro, one of the members of the Bank’s rate-setting monetary policy committee, said inflation in the UK was on track to fall rapidly this year despite concerns from others on the nine-strong panel that it could remain at persistently higher levels.
Speaking to MPs on the Commons Treasury committee, the independent economist said inflation was “pretty much guaranteed” to fall this year unless there was a new global shock and that interest rates were “too high right now” at 4%.
“Unless there is another big development that we don’t know about, and we have a massive energy shock – or something that’s not on the cards – then I think the fall in inflation is pretty much guaranteed.”
She said the full impact on the economy from 10 interest rate increases in succession from the central bank – the latest of which was last week – was yet to be felt, while the rise in global energy prices after Russia’s invasion of Ukraine in February last year would drop from the calculation of the annual inflation rate.
The annual inflation rate has fallen back from a peak of 11.1% in October to 10.5% in December, which is still among the highest levels since 1982. Official figures for January are due to be published next week.
Tenreyro said that only about one-fifth of the impact from higher borrowing costs had come through, while warning that interest rates could need to be cut this year as the UK economy comes under strain.
“The rest is still to come,” she said. “In my view, rates are too high right now.”
Threadneedle Street last week increased its base rate by 0.5 percentage points to 4%, the highest level since the 2008 financial crisis, while forecasting that inflation would fall rapidly this year alongside a shallow recession.
The impact of rate increases comes with a lag because many households and businesses fix their borrowing costs. As many as 2.7 million homeowners are expected to pay at least £100 a month more to refinance their mortgages at higher rates this year.
Andrew Bailey, the Bank’s governor, told MPs at the same session that while inflation was expected to “fall very rapidly” this year, there were risks that it could prove more persistent. “We have got the largest upside skew on a forecast we’ve ever had on inflation,” he said.
Bailey said there were signs of inflationary pressure fading in the labour market, although he warned that it was too soon to be conclusive. “I do think we have turned a corner in terms of headline inflation. It has not only fallen, it is now under what we thought it would be in the November report. But we need to see more evidence that this process will take effect,” he said.
Financial markets expect the Bank will raise interest rates by a further 0.25 percentage points this year, before a possible cut in borrowing costs before the end of 2023 amid fading inflation and as the economy struggles for growth.
Asked by Anthony Browne, a Conservative member of the Treasury committee, whether a pay rise for public sector workers close to the rate of inflation could add to wider inflationary pressure, Bailey said it would depend how it was funded.
Suggesting that taxes could need to be raised to counterbalance the economic stimulus of putting more money in workers’ pockets, which could boost demand for goods and services, he said: “I’ll be careful what I say here. I don’t think you can say there is no effect. I really don’t think you can say that. But I think it does depend on how it is funded, frankly. In the economics of it, I think it depends whether you raise taxes or whether you borrow.”
Rishi Sunak has argued that a bigger pay rise for nurses, teachers and other public sector workers is unaffordable and would fuel inflation, although he has faced stiff criticism from trade unions and Labour amid widespread strikes and record NHS waiting times.
Huw Pill, the Bank’s chief economist, said there was “certainly the potential” that bigger public sector pay rises could stoke inflation and force the central bank to raise interest rates by more than expected. However, in response to Browne’s question focused only on the impact of public sector pay, he suggested this was also true of private sector wages, as well as companies pushing up their prices.
“Its the irreconcilability of everyone asking for a bigger share of that pie which drives inflation,” he said.
