Interest rates set to rise? Dr Andrew Sentance would like to think so.

July 13, 2010

I attended a very enlightening speech today from Dr Andrew Sentance, Monetary Policy Committee member at the Bank of England.  Taking place at the Hilton Hotel, Reading and hosted by the Thames Valley Chamber of Commerce this was what’s known as an ‘on the record’ speech.  As a result there were representatives from many financial media organisations such as Reuters and Bloomberg.

Dr Sentance used the speech to explain how his view of economic prospects has shifted and why he voted for a small rise in interest rates in June.

Dr Sentance began by explaining that last year the economic backdrop was one of sharp falls in demand and rising unemployment, uncertainty about recovery prospects and a general expectation of persistent below target inflation. “A year on, however, the economic situation has changed,”.  He described a number of features of the current economic situation that he believes are very different from the expectations of last summer.

He argued that the world economy has bounced back strongly, and while uncertainties persist, “…worries about possible uneven-ness in the pace of global growth should not be confused with signs of a ‘double-dip’ recession”. In turn, he stated that he believes that “…the UK economy has also turned around since last summer”.  He pointed to a reverse in the downward shift in money spending as well as positive business survey outturns as evidence of a rebound. He also believes that expectations of large margins of spare capacity have not been borne out by the available data. And he suggested this may, along with the depreciation of sterling, help to explain the failure of inflation to drop back in the way the MPC expected a year ago.

Andrew Sentance concluded by saying: “In my experience, recoveries have momentum. While growth might not be totally steady and even across sectors, as recovery progresses, various mechanisms begin to operate which can give it added momentum”. He added: “A year ago, the predominant worry was that inflation could be significantly depressed by the impact of the recession. That risk did not materialise. And while I’m not yet worried that we face a major and serious risk in the opposite direction, I do think we need to adjust the policy settings we put in place to head off the downside risks to inflation identified in the immediate aftermath of the big financial shocks in late 2008 and early 2009″.  He also added that whilst there may be some nervousness about the economic recovery in the UK that this should not influence the MPC decision making.

Dr Sentance was keen to use the opportunity to give a message to the media about the choice of words they may use to report on the 0.25% Base Rate rise he would like to see.  Out go the words “rate hike” and “tightening of policy” due to the potentially negative feelings these could generate.  His preference being for language such as “slowing” or “normalisation of policy”.

He described the UK economy as a “patient coming out of intensive care and moving into the recovery ward” and that in this scenario a change in prescription (monetary policy) would be necessary.

Overall it was an extremely interesting speech which much food for thought.  He certainly makes a compelling argument for a gradual increase in Base Rate and one suspects it is only a matter of time before his MPC colleagues start to come around to his way of thinking.

If you wish to view the text of the entire speech this is accessible via the Bank of England website.

Posted by Lorraine | Filed Under Uncategorized 

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