(Bloomberg) -- UK interest rates are likely to settle at just above 4% over the longer term as deglobalization and the end of China’s demographic boom put upward pressure on inflation, according to Charles Goodhart, a founding member of the Bank of England’s Monetary Policy Committee.
With major central banks cutting rates, attention is shifting to the “neutral” level at which they neither simulate nor restrict growth. Andrew Bailey, the BOE governor, told the Kent Messenger newspaper last month he “would not expect” a return to the “very low interest rates” seen after the 2008 financial crisis but could not say where they will settle “with any great accuracy.”
Goodhart, a London School of Economics emeritus professor, considers the last 30 years of depressed inflation as an anomaly and for the UK’s real neutral rate to return to its historical average since 1800 at just above 2%. Adding the BOE’s 2% inflation target to that would put the BOE’s nominal policy rate at just over 4%.
“I think it’s realistic,” he told Bloomberg in an interview. “If I had to make a guess over the next 20 years, I would say I would expect something a little bit higher.” He added that he would also leave the BOE’s inflation target at 2%, rejecting calls for a review of the framework that might lift it to 2.5% to 3%.
The neutral rate of interest is of increasing importance because it will determine when the BOE and others, like the US Federal Reserve and the European Central Bank, should stop easing policy. Some economists argue it is around 3%.
At the moment, markets expect UK rates to settle at about 3.5% but estimates are simply educated guesses because the neutral rate cannot be observed. In 2022, Bailey said he expected the neutral rate “to stay low” but last year said economic developments could cause it to “shift up.”
Goodhart believes it will be higher than in the recent past because the “extraordinary” 30-year decline in rates is over. China’s shrinking workforce will mean its ability “to go on producing ever cheaper goods won’t last.” Deglobalization as countries seek to reshore or “friendshore” critical supply chains will push up prices, and smaller working populations relative to non-working older people will bid up wages.
He added that the huge fiscal deficits following Covid among governments in advanced economies will also drive up the cost of borrowing due to the greater demand for funding. “The deficit and debt situation in many countries is really serious without any clear indication of how this can be handled,” Goodhart said.
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