MNI INTERVIEW:No Fast BOE Cuts If Inflation Slides-OBR's Miles

The Bank of England is likely to keep rates near their peak for some time and not respond with rapid rate large cuts if inflation undershoots the 2% target for a lengthy period as assumed by the official fiscal forecaster in its March Budget projections, top Office for Budget Responsibility official and former BOE Monetary Policy Committee member David Miles told MNI.

The OBR's projections showed CPI inflation dropping from 6.3% in 2023 to 0.9% in 2024, and then to just 0.1% in 2025 and 0.5% in 2026 based on a market rate path for Bank Rate to rise from its current 4.0% to a short-lived peak of 4.3% in Q3 2023 followed by a gradual drift down to around 3.0% by around the end of the forecast horizon in 2028. Miles rejected the interpretation that the prolonged inflation undershoot foreseen means the market curve is in the wrong place.

"You could look at the forecast of inflation which for a fairly long period, a couple of years, undershoots the Bank of England target and you might say 'well, wouldn't the Bank of England be cutting rates aggressively then?’” he said.

"I think though you can see a situation where having dramatically overshot the inflation rate for much of last year and indeed the first part of this year the Bank of England would be willing to look through a period of a much smaller undershoot relative to the 2% target without thinking that the appropriate policy is to slash interest rates," Miles added.

SYMMETRICAL RESPONSE

The BOE did not respond with very aggressive hikes to the rise in inflation to close to 11% and it is likely to act symmetrically. (See MNI POLICY: BOE On Course For Hold Unless Data Surprises)

"Missing the target in the other direction, although by rather a lot less, I doubt would make the Bank think the right thing to do would be to slash rates back to close to zero percent to get it back very quickly" he said,

The OBR came up with a rosier picture on growth than the vast majority of independent forecasters, with its real GDP projection of -0.2% for 2023 0.3 percentage point above the BOE's and its 2024 forecast of 1.8% 0.9 point above the independent average based on the Treasury's survey compilation.

Miles said the OBR should not worry about being an outlier, even though fiscal policy is set on its projections.

"For the last year or so we have been pretty consistently on the optimistic side of the consensus and that is still true. In some sense it does leave one exposed because if it turns out the middle of the consensus is how things play out people will say 'well, what were they doing'?

"I think the risk averse strategy of saying 'let's stick with the pack and if we are wrong we are all wrong together and we can say well, everybody else was looking at it this way as well is a bit intellectually feeble," Miles said.

SMALL MARGIN FOR ERROR ON DEBT RULE

Miles said a key chart in the OBR's fiscal projections published following the Budget on Wednesday showed just how small a margin for error the Treasury has left to hit the government's target of achieving a decline in debt-to-GDP in five years, with the projections indicating a buffer of just GBP6.5 billion.

"The probability given past volatility and various other things of hitting the target on the debt-to-GDP ratio is a little bit better than 50% ... In an economy that is three trillion and in an economy with a stock of debt of about three trillion, headroom of GBP6.5 billion is pretty small," he said.