(Bloomberg) — Bank of England Chief Economist Huw Pill said interest rates could drop this year as a “reward” to the economy for bringing inflation down.
Pill said borrowing costs are on track to fall so long as inflation declines as expected — and that the Consumer Prices Index doesn’t need to drop all the way to the 2% target before the cuts can begin. Monetary policy is now “on a different path than we were over the course of last year,” he said.
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The remarks in a webcast Q&A signal a shift in the UK central bank’s communication on its policy that started last week, when it held rates at 5.25% and signaled cuts are under consideration. At its last meeting in December, the next move was more likely to be a rate rise.
“So, if you like, declines in interest rates are our reward to the economy for better performance on inflation,” Pill said Monday. “The outlook for monetary policy has shifted.”
It’s “premature” to talk about rate cuts right now but as underlying domestic inflationary pressures start to wane, “as that process works through, we can begin to reduce bank rate.”
The key measures the BOE is looking at are wages and services prices. He stressed that they do not need to be back down at the target 2% level because interest rates are already “restrictive,” meaning they are suppressing activity and prices.
“We don’t need to see inflation get back to 2% on a on an underlying basis in order to begin to reduce bank rate because we’re at a restrictive level. We can reduce bank rate a little bit and monetary policy would still be restrictive,” he said.
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The BOE continue to watch events in the Middle East closely for potential threats to inflation. “On balance, over the next year or 18 months, because of events in the Middle East, we thing that it’s slightly more likely that inflation will surprise on the upside than the downside and, other things equal, that’s reason to maintain restriction in the economy for some time,” Pill said.
“If we were to see high energy prices leading to second round effects that boost the underlying component of domestic inflation maybe that would be a reason to add more restriction into the monatary policy stance, either by raising bank rate – that wouldn’t be my expectation but it’s possible – or maintaining the current level of bank rate for longer.”
“Maybe we get some good news. Maybe the underlying inflation dynamic is dissipating quicker than we thought and perhaps we brought interest rates down more quickly than thought.”
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