MNI INTERVIEW: UK Rates May Need To Rise To 6% - Buiter

The Bank of England must keep raising interest rates aggressively for the foreseeable future, possibly bringing its policy rate up to 6% to deal with increasingly-entrenched inflation, former Monetary Policy Committee member Willem Buiter told MNI.

The BOE meets this week under the shadow of gilt market turbulence that forced an emergency central bank intervention to protect pension funds, and is expected to deliver a 75-basis-point rate hike.

“The prospect for the foreseeable future, for all of 2023, is for significantly higher interest rates. In the UK, certainly higher than 5, possibly up to 6%,” said Buiter, also former Citigroup global chief economist, in an interview with MNI’s FedSpeak podcast.

“Interest rates at the moment are 2-¼%, they’re not even in restrictive territory yet. My guesstimate of where the neutral policy rate is is 2-½%, so the Bank of England is knocking at the door of restrictive monetary policy but is still on balance expansionary.”

Buiter acknowledged that flagging UK GDP growth leaves the BOE in an uncomfortable position of having to inflict additional pain on an already-battered economy. (See MNI POLICY: Differences Within BOE Focus On Risks To Growth)

“The economy is likely either in recession or about to go into recession, but it will have to go into a quite material and sustained recession if the inflation we’re seeing at the moment is to be squeezed out of the system in a lasting manner,” he said. At the same time, however, “the 10.1% headline inflation rate and even core inflation of 6.5% is calling out loudly for higher rates.”

FINANCIAL FRAGILITY

One caveat to the BOE’s monetary tightening is a still-challenging financial stability backdrop, after market turbulence prompted a change of prime minister and the new government team has yet to fully unveil its economic proposals.

“It’s still looks as though the situation is extremely fragile and the risk of a resumption of the kind of financial unrest that we saw late September, early October is definitely material,” Buiter said.

If that were the case, he said, the central bank would not hesitate to intervene again despite assurances that its recent short-term buying program was time-limited.

“They may well be forced at times to engage in asset purchases or collateralized lending operations that amount, in addition to addressing financial stability, to expansionary monetary policy as well, which therefore aggravates the inflation problem,” he said. “But there’s no way to get away from that dilemma. They can try to minimize the inflationary consequences of their stability-enhancing measures.”

Buiter thinks the Bank of England should have sterilized, or at least have aimed to soon sterilize, the asset purchases made between Sept 28th and Oct 14th. “They chose not to do so. That I think sent the wrong signal. It made it into unnecessarily expansionary monetary policy,” he said.

Regulators should have been more attentive to the risks in pension fund strategies that led to the gilt market shock, he said, but added that missing the likely source of the next crisis was nothing new for central bankers.