MNI INSIGHT: BOE Vlieghe Clear Bank Rate Rise Likely Soon

--Vlieghe Still Sees Equilibrium Rate Low

--Still Sees Long-Term Downward Pressure From Demographics

--His Remarks Made Following Market Moving Speech Friday

By David Robinson

     LONDON (MNI) - Bank of England Monetary Policy Committee Gertjan Vlieghe

rocked markets Friday by giving his support to the majority view on the MPC that

a rate hike could well be justified in coming months, However, he still firmly

believes that equilibrium real interest rates are low and that demographics may

push them lower still.

     Vlieghe's view is that recent economic data support the case for tightening

soon. At the same time new Bank research tallies with his belief that

demographics and distribution of income have, and will continue, to put downward

pressure on real equilibrium interest rates, so when Bank Rate starts to rise it

may not be long before it hits its ceiling.

     A debate has been raging over the implications of ageing in advanced

economies. One view, associated with former MPC member Charles Goodhart and

strategist Toby Nangle, is that the baby boomer phenomena which led to a rising

proportion of working age people created a labour glut, which depressed wage

growth and lowered demand for capital, as labour was relatively cheap, thereby

pushing down on real interest rates. 

     On this view, with the baby boomers moving into retirement, and with

longevity increasing, greater labour scarcity may put upward pressure on real

interest rates. Soon to be published BOE research, led by Gregory Thwaites,

backed the opposing view, finding that an ageing population would continue to

push down on real interest rates and Vlieghe is firmly in this camp.

     Thwaites' research was based on the assumption that what matters in

determining real interest rates is the stock of wealth built-up by the older

generation and that this will fall only slowly and partially in retirement.

     "The really short way to explain that is .. whether you think it is the

flow of savings that matters or the stock of savings. They (Goodhart, Nangle)

are making a point that maybe the flow is about to change but I am saying that

it's the stock (that's key)," Vlieghe told Market News after his speech at the

Society of Business Economists.

     Vlieghe believes the view that ageing populations can drive up real

interest rates does not mesh with the facts.

     "The problem I have with their (Goodhart, Nangle) version of the story is

it can't explain Japan. It goes clearly the wrong way," he said.

     Japan's ageing population has experienced a very long period of ultra-low

rates.

     Asked if he believed demographics would continue to weigh on the real

equilibrium interest rate Vlieghe said "Correct. It is either low or going a bit

lower still. That is the point I make."

     Vlieghe also gave reporters a succinct summary of why he believed that the

MPC has been clear in its messaging on how the case for near-term tightening in

monetary policy has evolved and strengthened.

     Market rate expectations moved sharply higher on Thursday when the MPC's

September minutes stated that for the majority on the committee a rate hike may

be justified "in coming months," a view which Vlieghe endorsed. 

     The MPC had warned in its August minutes that policy "could need to be

tightened by a somewhat greater extent over the forecast period than the path

implied by the yield curve (used for the August Inflation Report projections)."

     Markets did not respond to that warning and in September the MPC toughened

the rhetoric by warning that a hike could materialize in coming months.

     "Go back to our big monetary policy messages over the past year and,

actually, I think there has been a very steady evolution, very clearly linked to

the data ... We started last summer by saying we have just eased but it looks

like we are going to ease more. Then by November we said now it can go either

direction," Vlieghe said.

     By February the MPC was saying that over the three-year forecast horizon

Bank Rate would probably go up a bit "but the big question is over when" and in

August it was again warning the market that it was underestimating tightening.

     "We have been pushing that line throughout and we have just been explaining

that as the output gap closes our tolerance to this inflation overshoot becomes

smaller so, obviously, the point at which you actually pull the trigger is

coming closer," Vlieghe said.

     "As far as I am concerned it has been a very continuous evolution of that

message and that has continued into the September minutes. We are just saying

that as long as the economy keeps behaving like this then the moment (for a rate

hike) is going to come," he said.

     The MPC member was also clear that the first hike, now widely seen as more

probable than not in November, is not likely to be a one-off which simply

reverses the 25 basis point cut in August.

     Whether it is the start of a tightening cycle "will depend on the data but

.. if you go back to the August Report what we said was that under our central

scenario .. if the downside risks don't materialize and if the data moves in

line with our central projection then we think we are going to end up tightening

more than the market was pricing-in," Vlieghe said.

     "At that point, the market was pricing in two hikes in three years so we

were saying more than that so it was obviously more than just unwinding (the

cut) last August. But we are making that judgement over a three year period and

it will depend on how the data hold-up," he said.

     The MPC was, clearly, well aware of the impact its announcement that a rate

hike could materialize in coming months would have and with Bank Governor Mark

Carney and Vlieghe, who was perceived to be the most dovish MPC member, backing

that line near-term tightening now looks near inevitable.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

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