(Bloomberg) -- Bank of England Deputy Governor Clare Lombardelli said policymakers should press ahead with interest-rate cuts carefully amid concerns that wage growth and inflation will not drop away as quickly as hoped.
Delivering her first speech since joining the BOE earlier this year, Lombardelli said the UK has made “good progress on disinflation” but “the more persistent components of inflation and uncertainties around how the labor market will evolve are cause for concern.”
“I view the probabilities of downside and upside risks to inflation as broadly balanced. But at this point I am more worried about the possible consequences if the upside materialised, as this could require a more costly monetary policy response.”
Lombardelli, who voted with the majority to cut rates a quarter point to 4.75% at this month’s meeting, was talking at the annual BOE Watchers Conference in London. She backed the consensus on the Monetary Policy Committee that restrictive territory should be removed “gradually.”
The topic of her talk was the bank’s response to the Bernanke Review of the BOE’s forecasting record, published in April. The former US Federal Reserve Chair Ben Bernanke said an overhaul of the modelling and data arrangements was needed alongside a new approach to communicating the bank’s forecast.
Lombardelli, who is leading the BOE’s response, said: “This program is going to take time to work through – years not months.” She added: “I think it will be a real mistake to be honest if we kind of rush it.”
On monetary policy, Lombardelli said the level of interest rates was “comfortably in restrictive territory at the moment” and supported “a gradual removal of monetary policy restriction” but the data over the coming months will be critical and need “careful observation.” Markets expect the bank to cut rates to 4% by the end of next year.
The path of wage growth remains a particular concern and the new Labour government’s policies have added to the uncertainty, she said. “There are some signs that the process of wage disinflation may be slowing, so it’s too early to declare victory on inflation. It’s often been said that the last mile may be the hardest, and that’s where we are now.”
The government’s plan to increase the minimum wage, its tax hikes on employment and changes to workers rights have contributed to “large uncertainty” around the labor market and wage developments, she added.
Employment Costs
Employers have threatened to put up prices to cover the cost of a £26 billion ($32.7 billion) increase in employers’ National Insurance Contributions at the budget last month, on top of which a 6.7% increase in the minimum wage next April risks driving up pay settlements. The BOE’s own surveys have found that business is worried about the effects of the higher minimum wage.
The picture was further complicated by problems with the official Labour Force Survey, which was making it hard to judge how tight the labor market really is, she said.
Lombardelli also cautioned against reading too much into last week’s weak business activity data, which suggested the economy may be entering a slump that might require faster rate cuts. “I don’t take a strong signal from a single release,” Lombardelli said, referring to the flash PMI.
Bernanke recommended switching from fan charts that provide a probability of different outcomes for the economy and inflation to scenarios to communicate more clearly how the bank would react to different events. The BOE has since committed to using scenarios.
He also urged the bank to consider incorporating its own forecast of the path for interest rates rather than slavishly follow the market curve, which has in the past complicated the communication.
Lombardelli said the review “in parts makes for uncomfortable reading” and indicated that she is open to the idea of using the BOE’s own projections for rates with the new scenarios. “We will consider whether to publish the forecast with a modelled endogenous path for policy, either instead of, or alongside, a forecast conditioned on the market path for interest rates,” she said.
Some economists have urged the BOE to follow the Fed’s “dot plot,” an anonymous depiction of how each individual Fed policymaker sees the interest rate path evolving. Lombardelli suggested the BOE would not follow suit, saying it was “not as simple as it sounds.”
--With assistance from Irina Anghel.
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