Bank of England Monetary Policy Committee member Catherine Mann says it is better to raise interest rates too high, rather than not high enough.
Mann says undershooting rates is more costly than overshooting, because that would leave high inflation in the economy for longer, which would then require even higher rates to flush out.
“This is why I would rather err on the side of over-tightening,” Mann told the Canadian Association for Business Economics today.
She says: “Monetary policy transmits through financial markets to price setting and the real economy explicitly via an expectations channel.
“Therefore, duration above target matters for policy risk assessment — the longer inflation remains way above target, the more difficult it will be and the activity costs greater to ultimately get inflation to target.”
Mann adds: “To pause or to hold the policy rate lower for longer risks inflation becoming more deeply embedded, which would then require more tightening in total, to both change inflation itself and to wring-out the embedded inflation that comes from the sustained duration above target.”
Her comments come as the MPC is expected to raise rates by 25 basis points from its current level of 5.25% after its meeting on 21 September.
This would be the 15th rate rise in a row, taking it to the highest level for at least 15 years.
This comes amid the Bank’s battle against inflation, which fell to 6.8% in the year to July from 7.9% in June, but still remains almost three-and-a-half times higher than its 2% target.
Markets expect the base rate to hit 5.7% by the end of the year.
High borrowing costs, affect swap rates, which in turn push up mortgage rates.
Mann adds that she is worried that core inflation — which does not track goods and services such as food and energy that are more prone to foreign shocks — has been “at over 6% for over a year by now”.
She adds that it is the right time to favour interest rates “tightening further in order to prevent the risks of further inflation persistence from crystallizing.
However, Mann adds: “But, if I am wrong, and inflation decelerates more quickly and activity deteriorates more significantly, I will not hesitate to cut rates.”
