MNI INTERVIEW: Robust Policy Backs BOE Hike - Ex-MPC Saunders

The Bank of England should lean towards hiking rates in response to the energy shock rather than waiting for evidence of a pickup in wages, former Monetary Policy Committee member Michael Saunders told MNI, in line with the “robust” approach to policy championed by the BOE’s present Chief Economist Huw Pill.

The March YouGov Citi survey has already pointed to worryingly high inflation expectations, and further evidence along these lines may be enough to prompt a minority on the Monetary Policy Committee to vote for a hike later this month, Saunders said in an interview, adding that he agreed with Pill’s argument for policy aimed at 'a not-too-bad' outcome across a range of scenarios including high inflation expectations.

"You may well get some on the committee voting to hike at the April meeting. One, two maybe, not a majority, but maybe some of them because they were saying, 'look, inflation expectations, we've seen two months, that's enough evidence for me,’  but others might prefer to wait somewhat longer,” he said.

"You couldn't necessarily say that the decision to wait for three months of evidence is wrong. That would be a valid argument. The whole point about the robust approach is, if you see the evidence in inflation expectations, you don't wait to see it in pay growth," said Saunders, now a senior consultant to Oxford Economics, 

"A robust approach, I think, points you more towards tightening.” (See MNI INTERVIEW: Oil Shock Means Europe Needs Higher Rates)

ROBUST APPROACH

Chief Economist Pill argued for “robust” policy in a speech last month, and Saunders believes it can support hiking despite deep uncertainty over whether the Iran conflict will propel pay growth next year. The former MPC member argues against a prolonged wait-and-see approach, saying that the cost of reversing a hike in current circumstances would be low.

While some members on the MPC calculate that labour market slack may constrain pay growth, Saunders said policy should assume that outcomes are inherently uncertain. (See MNI POLICY: Iran War Shock To Magnify BOE's MPC Fractures)

"You're in a position of unavoidable uncertainty, right? You can't just wish it away and pretend it's not there, so you've got to factor that uncertainty into your policy making, rather than just plump for one alternative or the other," he said.

Economists’ consensus is that the BOE will keep Bank Rate at 3.75% in April, though around 20bp of tightening are priced in by June. 

"The question is, how much evidence do you need to see to start to move?” said Saunders. “I don't think they need to wait until they see pay growth picking up, because that's very much at the end of the process. I think that period of higher inflation expectations would be enough. And the thing which I'm uncertain of is, well, how much evidence on inflation expectations do you need to see?" 

LIMITED REVERSAL COSTS

Saunders disagreed with arguments by some economists that MPC members should vote to keep rates unchanged should they consider that only a single 25-basis-point hike is warranted.

"The idea that you would rather not change rates if you can possibly help it ... only makes sense if you think that changing interest rates is very costly, or that reversing course is very costly," Saunders said.

"I don't think reversal costs are terribly high at all, most of the time, unless you're having to reverse course the next month and, right now, with such a changeable outlook, I think reversal costs would be very low indeed," he said.

"Let’s say you hold rates and the upside second-round effects case comes through, and you're still in the wait-and-see mode ... By the time you start to move you really do need to move them an awfully long way, because the chances are that the fact that you've delayed itself has fuelled a further rise in inflation expectations.”

The BOE's Decision Maker Panel survey, with the next one out Friday and with its focus on firms' own price and wage expectations a year out, is often cited by policymakers, but Saunders cautioned against placing too much weight on it.

"The question about pay growth a year ahead doesn't lead by a year. You could do statistical tests on it in leads by about five months. So that's still worth something, but it's a relatively short lead guide, and you look at how much did it signal [average weekly earnings] growth in the last few years, and it greatly understated … the peak.”