Interest rate cuts should still be a “way off” given the danger of persistent inflation in the UK, a Bank of England rate-setter said.
“The UK economy has faced the double whammy of a very tight labour market and a terms of trade shock from energy prices,” Megan Greene, an external member of the Monetary Policy Committee (MPC) said.
“Inflation persistence is therefore a greater threat for it than the US. But market pricing for interest rates does not reflect this,” she warned in a Financial Times column.
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“Rate cuts in the UK should still be a way off,” she added.
Traders think the Bank of England is likely to start cutting interest rates in the summer. In the US, in contrast, markets have increasingly pushed back the timing of the first rate cut.
Following yesterday’s inflation overshoot, the third consecutive upside surprise, markets think there is just a 20 per cent chance that the Fed will cut rates in June. Some economists have even raised the possibility there will be no rate cuts in 2024.
Greene argued that the UK was actually more at risk of persistent inflation than the US because it has “much more constraint” on the supply side.
The Bank of England estimates that the UK’s potential growth rate, which combines potential productivity growth and labour supply, will rise from just one per cent this year to 1.3 per cent by 2026.
The Congressional Budget Office meanwhile estimates US potential growth at 2.2 per cent over the same period.
“This means the US economy can withstand more demand in the economy before it turns inflationary,” she said.
Slow potential growth in the UK likely reflects the slowdown in business investment since Brexit and the drop-off in labour market participation compared to pre-pandemic
She noted that services inflation in the UK, which stands at over six per cent, is much higher than in the US while wage growth is also running much hotter.
Although there had been progress on both of these metrics, she said they still remain higher than other advanced economies. “This last mile may prove the hardest,” she warned.
In the last MPC meeting, Greene was in the majority who voted to hold rates at a post-financial crisis high of 5.25 per cent. Having joined the MPC in July last year, she has been one of the more hawkish members of the MPC.