MNI INTERVIEW: R* At Top Of BOE Range And Rising - NIESR Head
MNI (LONDON) - The UK’s long-run neutral rate of interest probably lies at the top of the range of recent estimates and is likely to continue to increase thanks to growing government borrowing and demographic pressures, interim director of the National Institute of Economic and Social Research Stephen Millard told MNI.
"For me, the trend is further up as the need to increase borrowing will continue," said Millard, speaking after the Bank of England updated its estimates of R* for the first time since 2018 in its February Monetary Policy Report.
NIESR’s view is that R* now lies at the higher end of the range of estimates presented by the BOE, which stretch from Bank staff models suggesting the metric has risen by 25-75 basis points to somewhere between 2% and 3% in nominal terms, to financial-market-based measures which indicate as much as 4%.
"We think it's around about 4%, so we're at the top of that range ... A range of three to four, I'm quite happy with that. I'm quite happy being at the top end of it," Millard said in an interview, adding that pressures on R*, with increasing demands for government borrowing, are clearly upwards.
"I think we're going to see a large increase in defence spending. And there's, of course, the transition towards net zero that's going to require lots of investment, which, again, is going to require an increase in borrowing." (See MNI POLICY: BOE Looks Set To Edge Up Neutral Rate Estimate)
DEMOGRAPHICS WEIGH
Revisions of R* in previous years had indicated the metric was falling, as an ageing population saved more. Millard noted, however, that enhanced saving is associated with those moving into retirement and not with retirees, who fund spending out of saving.
“That's where we have a slight disagreement between the Bank and us, because the Bank always talk about the aging population pushing down on R*, because it's pushing up on savings. But actually there will be a point where the retired population is really pushing down on savings, and that will be pushing up on R star," he said, specifying that this point arrives when a sizeable part of the population is aged 65 or older.
NOT RELIABLE POLICY GUIDE
In theory R* tells policymakers whether policy is restrictive or stimulative, but in practice it is just one indicator among many, Millard said, noting that the BOE’s emphasis on a range of estimates of the metric in its Monetary Policy Report probably reflects differences of opinion on the matter within the Monetary Policy Committee.
If the R* estimated range is "two to four and your actual rate is three. Does that mean the monetary policy is tight, or does it mean the monetary policy is loose? And the answer is you don't know, because it could be either in the range you have," Millard said, adding that "given the uncertainty, it is just not a practical tool for setting monetary policy."
While policymakers have recently talked about UK yield curves being driven higher by rising U.S. rates, distorting market signals regarding neutral, Millard called this a “red herring.” (See MNI INTERVIEW: Gilt Hit Weighs On Inflation - Ex-BOE Saunders)
"To the extent the financial markets are global, then R* will be a global concept. It will clear ... global savings against global investment," he said.