MNI POLICY: BOE Saunders Sees Faster Tightening Than Expected

By David Robinson

     LONDON (MNI) - Bank of England Monetary Policy Committee member Michael

Saunders warned in a speech on Thursday that capacity pressures are building in

the UK economy and rate hikes to return policy to a neutral stance may come

faster than markets have been expecting.

     Following are key points from his speech to business body the CBI:

     --Assuming a smooth Brexit, Saunders said that the market's expected path

for rate hikes was too shallow.

     "My own hunch is that ... capacity pressures will probably build somewhat

faster than envisaged in our latest Inflation Report projections, reinforcing

upward pressure on pay growth. In this case, we would probably need to return to

something like a neutral stance rather earlier than implied by the current yield

curve," he said.

     The Bank's November Inflation Report was conditioned on Bank Rate rising

from its current 0.75% to 1.0% by the end of 2019 and on up to around 1.4% at

the end of 2021. Rate expectations have been volatile of late on Brexit news,

with the single 2019 rate hike no longer fully priced-in in recent days.

     --Saunders said that his assumption of more rapid tightening was contingent

on the Brexit process going smoothly, which he acknowledged was uncertain.

     He stressed that policy could be tightened or eased in response to either a

no-deal Brexit or a smooth transition to a close relationship with the EU.

     "The monetary policy implications of different Brexit outcomes could go

either way, depending on the effects on supply, demand and the exchange rate,"

Saunders said.

     He pointed out that a no-deal Brexit would likely see currency

depreciation, declining investment and "The net effect would probably be higher

inflation and lower growth" which could be used to justify easing or tightening

depending on the magnitudes of the effects.

     -On demographics Saunders highlighted how the UK is an ageing society and

will become so more rapidly so if net immigration slows.

     Population ageing "is affecting the economy now and will continue to do so

in coming years."

     Twenty-five years ago, the number of people in the 20-49 age group was

roughly 40% greater than those aged 50 years and over, but now the two groups

are almost the same size and the latter is set to exceed the former in three to

four years.

     --Saunders noted that older age groups tend to save more, have more assets

and have less debt than younger ones which could reduce the potency of policy

tightening, as savers benefit from higher rates, although survey evidence shows

these effects are not yet clear in the UK.

     "If the monetary transmission mechanism does become less powerful then, all

else equal, monetary policy might need to be more active around a neutral stance

to stabilise the economy in the face of demand shocks," Saunders said.

     He said that there was evidence that ageing has lowered the neutral real

interest rate, R star, because of higher demand for safe assets, and that this

effect was already evident.

--MNI London Bureau; tel: +44 203-586-2223; email: david.robinson@marketnews.com

[TOPICS: M$B$$$,M$E$$$,M$$BE$]