MNI POLICY: BOE's Saunders Makes Case For Earlier Tightening

--Saunders Sees Policy Rising To Neutral Rate Earlier Than Markets Expect

By David Robinson

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

Saunders said the UK's output gap as probably closed and the economy is moving

into excess demand, with Bank Rate likely to have to go up to around its neutral

level earlier than markets are anticipating.

     Saunders' suggestion of tightening clashes with market pricing, which

suggests that the most likely outcome is a prolonged period of unchanged policy,

with no hike fully priced in through 2020 and a 30%-40% probability of a cut.

Saunders noted his assumptions were based on a smooth Brexit, which is widely

seen as increasingly less likely.

     --Saunders believes consumer spending may come in stronger than assumed in

the May Inflation Report, which projected household consumption growth slowing

this year and next.

     With unemployment staying low and relatively strong pay growth for middle

and lower earners "consumer spending will continue to outperform expectations -

probably growing at or slightly above the average pace of the last year or two."

     --Bank Rate "will probably need to rise further over the forecast period

than implied by the market path used in the May Inflation Report."

     That path showed Bank Rate increasing from its current 0.75% to 1.0% by the

second quarter of 2022.

     --Regarding the timing of policy tightening, Saunders said: "we probably

would have to return to something like a neutral stance earlier than markets

project."

     The MPC's recent assessment of the neutral rate put it at 2-3% in nominal

terms, or 0-1% in real terms, with a suggestion that it could be below this

level at present due to temporary factors.

     Saunders remarks entail substantially more tightening over the forecast

horizon than currently anticipated.

     --He highlighted the chilling effects of Brexit on investment, and said its

adverse effects came not just from greater uncertainty but also from investors'

more pessimistic view of the likely path for the economy.

     Saunders went on to say that if uncertainty fades as result of a smooth

Brexit, which is the basis for the MPC's central forecast , some of the pent up

investment demand should be released.

     Saunders' remarks, however, highlight how the MPC's central forecasts risks

becoming detached from market perceptions.

     With the Conservative Party leadership contest getting into full swing,

there is a market view that the chances of no deal may rise as candidates battle

to win over the largely pro-Brexit party membership.

     Saunders acknowledged the recovery in Brexit-related investment "is far

from certain. A worse central outlook for Brexit, or a series of repeated Brexit

cliff edges, could leave business confidence and investment weaker than

expected," he said.

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

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