The case for raising interest rates is “not compelling” unless energy prices remain higher for longer and create a larger impact across the wider economy, Bank of England policymaker Alan Taylor has said.
Taylor, a member of the Bank’s Monetary Policy Committee (MPC), played down the need to increase borrowing costs amid growing expectations that interest rates could rise. Speaking at the Dow Lecture at the National Institute of Economic and Social Research, he said higher energy costs so far appeared to be concentrated largely within the energy sector rather than spreading widely through the economy.
“Against that backdrop, the case for further rate increases is not compelling to me unless energy prices remain high for an extended period and also generate clearer signals of a transmission into broader inflation persistence,” Taylor said. He added that the Bank was actively monitoring indicators of whether those effects were becoming established.
Taylor said the Bank needed to remain “alert” to economic developments, but argued that any decision to raise rates should be based on evidence that so-called second-round effects were gaining momentum, rather than on the energy shock alone.
Second-round inflation effects can occur when higher prices lead workers to seek wage increases to protect their living standards, or when businesses raise prices because they expect consumer and market behaviour to change. Some Bank policymakers have said there have been limited signs of such effects in the UK economy as inflation has risen.
Taylor’s comments echoed remarks by Bank Governor Andrew Bailey on Monday. Bailey said there was “no question we are seeing the direct effects of the energy shock”, while describing the pass-through into the wider economy as currently “subdued”.
The direct effects described in the report include spikes in petrol and diesel prices and an increase in the price cap on household energy bills. The report attributes the energy shock to the US-Israel war with Iran.
Bailey also said that, although the Bank had not increased interest rates, maintaining that position would become more difficult if energy prices remained higher. Deputy Governor Clare Lombardelli recently said energy price pressures could lead to an increase in rates unless the economy showed particular weakness.
Bailey, Lombardelli and Taylor were among the six MPC members who voted to keep UK interest rates at 3.75% earlier this month, while three voted against maintaining the rate.
Looking beyond the immediate debate over a possible increase, Taylor said rates might eventually need to move lower if inflationary pressures eased and energy-related risks diminished. He said there would be a point when policy would need to move “in the other direction”, because keeping monetary policy unnecessarily restrictive would itself impose costs even if the risks had not disappeared entirely.
