MNI INTERVIEW: Rising Rents Shouldn't Defer BOE Rate Cuts

Elevated rental inflation poses a challenge to Bank of England communications as it approaches an easing cycle, but it should resist any temptation to delay cuts due to concerns over shelter costs, former senior New York Fed and BOE economist Gianluca Benigno told MNI.

Persistent services inflation is often cited by policymakers as a reason for caution over easing, but previous BOE rate increases have themselves contributed to pushing rents higher as landlords have faced higher mortgage payments, Benigno said in an interview.

While a BOE working paper using data up to 2019 found that rate hikes put upward pressure on accommodation costs for up to 12 to 20 months, the central bank’s communications tend to highlight the effect of higher rates on squeezing demand, and are likely to continue to do so as policy debate focusses on the timing of the first cut in the cycle. (See MNI BOE WATCH: BOE Holds, Hiking Bias Removed From Statement)

BOE policymakers "need to make it consistent with the narrative and you cannot come out with something that says that rental costs increase in the first 12 months following an increase in interest rates. The working paper emphasises the medium-run effects, but as I was reading it I would have been indeed worried (about) the shorter-run effects," Benigno said.

Rental prices rose by 6.5% in the 12 months to January, the joint highest level on record and accounting for 15.8% of services CPI inflation on the new index weighting. In 2023, rental accounted for 17.3% of services CPI, the third-largest component.

This impact of higher rates on squeezing some costs higher is likely to become more pronounced within overall inflation readings in coming months as energy and goods price disinflation tapers off, Benigno added.

RENTAL INFLATION TO OUTPACE CPI

While rental inflation has tended to be lower than the increase in total CPI in recent years, it is soon set to outpace the overall index.

There will be "a point at which these effects are no longer present to counterbalance the relatively high persistence of service inflation. And I fear these interest rate increases are actually working, especially in the first part of the transmission mechanism, against what the Bank of England is trying to achieve, what monetary policy is trying to achieve," he said. (See MNI INTERVIEW: Better ONS Data Suggest Easing UK Labour Market)

"We are talking about a 500-basis-point increase of interest rates in a relatively short period of time. So it's very hard for me not to think that it has not been a cost for many and that it will be passed through at some point.”

UK mortgagees typically take out short-term fixed mortgages, of two-to-five years and, Benigno said, "this is the year in which we should expect the effectiveness of monetary policy to be felt because there is more resetting of mortgages..”

There is a tension between what is in consumption baskets included in a central bank’s target and which items policymakers can actually impact, Benigno said.

"This tension is crucial because interest rates can have a disinflationary effect on certain components, let's say for example, durables and can have an inflationary effect on other components. So we need to balance that and policy can have very limited effects on other components like food,"" he said.