Britain needs higher interest rates to prevent inflation from heading back towards 3% and staying there for several years, according to Michael Saunders, one of the two dissenting Bank of England rate-setters to vote for a rise earlier this month.
Saunders said the UK economy was able to withstand the impact of higher credit costs after a steep fall in unemployment that paved the way for an increase in wages and higher prices in shops.
In a speech to business leaders in Cardiff, Saunders said he recognised that Brexit uncertainties weighed on consumer and business confidence, but warned that the decreasing number of migrant workers, which was already affecting some industries, would add to the pressure to raise wages.
“We do not need to be putting the brakes on so much that the economy weakens sharply,” he said.
“But our foot no longer needs to be quite so firmly on the accelerator in my view. A modest rise in rates would help ensure a sustainable return of inflation to target over time.”
Saunders is one of eight members of the monetary policy committee, having joined last year from the investment bank Citigroup.
Earlier this month, the MPC said Brexit uncertainties had discouraged some companies from awarding pay rises as it warned that rising prices and weak wage growth would continue to squeeze living standards this year.
The committee voted 6-2 to leave official borrowing costs at their all-time low of 0.25%, but it hinted that rates would have to rise over the coming year to keep inflation in check.
Since the vote, inflation has fallen from a recent peak of 2.9% to 2.6%, and a string of business and consumer confidence surveys have shown households and business leaders expecting a more gloomy outlook for the economy.
Saunders said: “There are considerable advantages to acting early enough to allow a gradual rise in interest rates. It is fully 10 years since the MPC last tightened monetary policy.
“Overall, balance sheets are much less fragile than 10 years ago, with lower debt to income ratios and higher levels of liquidity among companies and households. Banks have much stronger capital positions.
“A sizeable net balance of consumers, especially those with a mortgage, already expect interest rates to rise in the year ahead and hence have presumably incorporated this in spending decisions. So I do not expect a modest rise in rates will have a disproportionate effect on spending.
“Nevertheless, many borrowers have never faced a rate hike. It would be preferable to have the space to move gradually, observing the effects as we go. If we get behind the curve, we lose that space.”
