MPC member Saunders calls for higher interest rates to curb inflation

Bank of England rate setter Michael Saunders has used a speech in Cardiff to explain the thinking behind his recent votes for higher interest rates.

Saunders, an external member of the Bank's Monetary Policy Committee, said "a modest rise" in interest rates is needed to return currently high inflation sustainably back to its 2% target.

Speaking at the Park Plaza Hotel in the Welsh capital, Saunders, who voted to in the June and August MPC meetings to lift the bank rate by 25 basis points after voting for unchanged rates at earlier meetings, said the tradeoff between above-target inflation and below-potential output had "shifted markedly" in recent quarters.

Inflation has held steady at 2.6% for the last two months, well above target, while the 42-year unemployment rate was slightly below a the MPC's ideal equilibrium.

"The prospective tradeoff is beyond my limits of tolerance, with the likelihood of an early elimination of slack and an extended period of above-target inflation," the speech read.

"We do not need to be putting the brakes on so much that the economy weakens sharply. But, our foot no longer needs to be quite so firmly on the accelerator in my view.

"A modest rise in rates would help ensure a sustainable return of inflation to target over time."

But Saunders acknowledged that there were risks that the Brexit process "might be bumpy, and could undermine business and consumer confidence", which external surveys and economists already seemed to be suggesting.

In the event of such a bumpy Brexit scenario, where inward migration falls he predicted asset markets would also adjust, including sterling.

Monetary policy in the event of a Bumpy Brexit "are not automatic" and "could in theory go either way", he said, depending on the combined effects on demand, supply, and the exchange rate.

"In my view, we should not maintain an overly loose stance as insurance against this scenario. Rather, we should be prepared to respond as needed if it happens."

Economists at Oxford Economics said the speech "painted a more upbeat picture of the economy than the recent inflation report".

"The key difference between Saunders and the majority is his willingness to act without hard evidence that underlying inflationary pressures are building. And given that this evidence seems unlikely to materialise for some time, we expect him to remain firmly in the minority."