Outgoing MPC member
Ian McCafferty predicts rates below 5% and wages up 4%
The era of low
interest rates will last for at least another 20 years, despite gently rising official borrowing costs in the coming years, one of the
Bank of England’s leading policymakers has forecast.
In a valedictory interview before leaving Threadneedle Street’s monetary policy committee (MPC) at the end of the month, Ian McCafferty said structural changes in the global economy meant UK borrowers and savers should get used to interest rates being “significantly” below the 5% average in the 10 years leading up to the financial crisis.
McCafferty said some of the factors that had resulted in global interest rates declining since the 1980s – including weak productivity and the build-up of savings by the baby-boomer generation – would eventually go into reverse. “It is too much to say never, that we won’t ever go back. But there is a 20-year horizon under which there will be factors keeping it low,” he said.
The long-term trend in global interest rates has an impact on the level of borrowing costs deemed necessary by the MPC to keep inflation in check and helps explain why official borrowing costs since early 2009 have been lower than at any time since the Bank was founded in 1694.
McCafferty said that while consumers and businesses should now be braced for further increases in their borrowing costs following last week’s increase, they would be limited and gradual. “Interest rates are going to be significantly below the 5% average in the first 10 years (1997-2007) of the MPC,” he said.
McCafferty, whose six-year stint as one of the four externally appointed MPC members ends this month, also said:
labour shortages would lead to an acceleration in wage growth to close to 4% next year;
the Bank of England had not left it too late to start tightening policy but would need to announce two quarter-point interest rate increases within the next 18 months to two years;
uncertainty caused by
Brexit had affected businesses far more than consumers and was causing investment to be weaker than otherwise would be the case.
McCafferty said that despite the “potentially huge risks” from Brexit, the Bank would need to respond to evidence that the lowest unemployment rate in more than 40 years was creating widespread skill shortages.
“If the economy continues to evolve as we [the MPC] expect, we are not going to get back to 2% inflation unless we have a modest but gradual reduction in the stimulus that has been provided.”
McCafferty said the City was currently pencilling in two interest rate rises in the next two years but that the increases would probably be “front-end loaded”.
He added that the unusual amount of uncertainty – mainly associated with Brexit – meant it was impossible to be definitive about the timing of future rate rises but foresaw “another couple in the next 18 months or two years. I don’t think that’s unreasonable as a rule of thumb”.
In March McCafferty was one of the first MPC members to vote for the Bank to raise rates from the emergency level of 0.5% reached during the depths of the financial crisis. Earlier this month the committee unanimously backed a tightening of policy.
“The labour market has shown significant signs of tightening in recent months,” McCafferty said. “Surveys and other measures are pointing to labour shortages as a constraint on output growth.”
The outgoing MPC member said that previously skill shortages were restricted to skilled occupations, but had now spread to unskilled sectors as well.
Despite the steady fall in unemployment as the economy has recovered from its worst recession since the second world war, wage inflation has been modest and earnings are currently growing at an annual rate of 2.5%.
The Bank is forecasting earnings growth to accelerate to 3.25% in 2019, but McCafferty said that if labour demand continued rising at its current pace there was a chance that wage inflation would go higher. “It might creep up towards 4%-ish,” he said.
Some City commentators have speculated that one reason behind the Bank’s decision to raise rates to 0.75% was the MPC’s desire to provide itself with more firepower in the event that the UK leaves the EU without a deal next spring.
McCafferty said the MPC had acted when it felt it needed to and that delay increased the chances of a more aggressive tightening later. “I don’t think we have left it too late,” he said. “But once you think a rate increase is appropriate you shouldn’t dally with the first one.”