MNI INTERVIEW: Fast Rates Transmission Argues For BOE Caution

MNI ((MNI) London) - MNI (LONDON) - The bulk of the monetary impact of Bank of England interest rate hikes may already have been felt, meaning that there is less tightening effect still on the way to further damp inflation and arguing for a more cautious approach to policy easing, senior Resolution Foundation and former BOE economist Simon Pittaway told MNI.

The Bank’s August Monetary Policy Report noted that the long end of the gilt market has been more responsive to rate changes than in previous rate cycles, Pittaway said. This may be linked to the decline of defined benefit pension schemes, making demand for gilts more variable.

“The MPC thinks that transmission via asset prices has been especially quick, because in this cycle long rates have moved particularly quickly,” he said in an interview, adding that if the effect of hikes does come through quickly, then “you might take that as a hawkish steer, that you're safer in keeping rates where they are, or having a slower downward path during the cutting cycle”.

Pittaway noted that it is tricky to square what the Bank's Financial Policy Committee has found with the Monetary Policy Committee's view on rapid policy transmission. The FPC in its latest report cited evidence of stickiness of transmission, with risky asset prices being supported by compressed spreads and aggregate housing affordability set to reach historically high levels.

Pittaway’s research has also pointed to the cushioning effect on rate transmission from the trend towards longer-term fixed-rate mortgages, an area which the Bank has previously estimated accounts for about a quarter of the total impact of monetary policy. (See MNI INTERVIEW: BOE Faces Deeper Rate Cuts On UK Savings Impact)

SAVING RATIO

Further adding to arguments for easing caution would be any rebound in housing market activity, he said, which would boost consumption, and particularly consumption of durable goods, which has been consistently weak. This could mean the saving ratio declines more quickly than anticipated in the August MPR, which saw it peaking at 12% in the third quarter of 2024 before falling only gradually, he added.

The UK’s saving ratio was lower than the G7 average all but one year between 1995 and 2021, with a rise in household wealth from 410% of GDP in 1997 to 630% driven by rising asset prices, according to Pittaway in a recent article.

With the new UK government looking to fill a large fiscal shortfall in its Oct 30 budget, and with Chancellor Rachel Reeves having ruled out rises in VAT, income or corporate taxes, Pittaway has estimated that an increase in capital gains tax could raise GBP7.5 billion.

 A CGT rise would not necessarily harm investment, or detract from the government's growth agenda, he said.

“If you want to incentivise people to put capital at risk,” he added, then there is scope for “investment release” rather than “reducing the rate on a wide range of realised gains.”

(Additional Reporting by Harrison Moore)