A rate-setter at the Bank of England backed a “cautious” approach to cutting interest rates despite the “uncomfortable” recent performance of the economy.
“The macroeconomic news over recent months has been uncomfortable,” Megan Greene, an external member of the Monetary Policy Committee (MPC) said.
“GDP has roughly flatlined since Spring of last year and expectations among firms for employment have deteriorated,” Greene continued.
But despite the subdued performance of the economy, Greene said monetary policy will have to “remain restrictive” in order to bring inflation back to the two per cent target.
“Domestic cost pressures have surprised us to the upside and our outlook for inflation includes a near-term jump in inflation alongside a larger negative output gap,” she continued.
Greene’s comments reflect the challenging outlook facing the Bank of England, as it seeks to securely anchor inflation back at two per cent.
The Bank cut interest rates by 25 basis points last week and halved their growth forecasts for 2025, reflecting the sluggish performance of the economy at the end of 2024.
However, officials were uncertain whether the growth slowdown has been driven by weakness in supply or demand, which would require different policy responses.
“How one’s policy views are impacted by the deterioration in activity data since last summer depends on how demand- or supply-driven one believes it to be,” Greene said at the Institute of Directors (IoD).
Greene said there was evidence of weakness in demand, such as the subdued levels of business and consumer confidence as well as growing weakness in the labour market.
This reflected the continued impact of high interest rates and the impact of the government’s maiden Budget. However, she was not convinced that this was the main factor behind economic weakness.
“For me, a potential issue with this narrative is that wage growth and domestic cost pressures have surprised us on the upside in recent months. This is what I’d expect to see in the face of more constrained supply relative to demand,” she said.
Private sector wage growth hit 6.0 per cent in the three months to November, up from 5.5 per cent in the previous period and comfortably ahead of the Bank’s forecasts.
Greene also noted that core goods and food prices had picked up and were “set to rise further,” largely on the back of domestic factors like higher labour costs.
“The evidence suggests to me that this weakness is more a question of constrained supply,” she said.
“That is to say it’s less likely inflation persistence will fade on its own accord, and more likely monetary policy will need to remain restrictive in order to either generate a negative output gap to bring inflation to target sustainably or to lean against structural shifts in the economy,” she said.