Low interest rate is storing up problems, MPC member warns

Monetary Policy Committee member Andrew Sentance, has warned that the longer interest rates are kept at exceptionally low levels, the greater the risk they will need to rise sharply in the future.

Sentance has voted a number of times for a rise in interest rates to 0.75%.

Speaking today at a lunch hosted by the Bank of England and CBI in Belfast, Sentance says there are three powerful arguments for a gradual rise in interest rates which have been evident for several months.

Firstly he says overseas markets and domestic private sector spending have been recovering for over a year now and look set to continue to grow.

He says: “The outlook for growth suggests the UK economy should be able to withstand a gradual rise in interest rates, even taking into account the impact of fiscal consolidation.”

Secondly, he argues that higher interest rates should help to exert a brake on above-target inflation and keep inflation expectations anchored around the 2% target.

He says: “There are significant upside risks to the forecast recently published in the Bank’s Inflation Report which could sustain the period of above-target inflation into 2012 and 2013. “

He believes the longer this period of relatively strong growth in consumer prices continues, the greater is the risk of a more fundamental upside shift in future expectations of inflation.

Raising Bank Rate sooner rather than later he says would provide more protection against these upside risks, by restraining the ability of firms to pass through higher costs into domestic prices and helping to limit import price inflation through the effect on the value of the pound.

He adds: “The third important argument is the extremely low level of interest rates we are starting from. Taken together with the monetary stimulus from Quantitative Easing, there is still likely to be a considerable support for growth from monetary policy even if interest rates are raised somewhat from their current level.

“I do not believe that the current economic conditions justify a continuation of this policy. The longer we keep interest rates at an exceptionally low level, the greater is the risk that Bank Rate would need to rise sharply in the future – creating a serious setback to business and consumer confidence.

“We should seek to avoid such a sudden lurch in policy. A gradual transition to higher interest rates appears much more likely to provide a stable and predictable approach to policy-making which enables the business community to plan sensibly for the future.”