Weak pound makes it harder to keep interest rates low, BoE's Cunliffe says

Weakness in Sterling made it more difficult for the Bank of England to keep interest rates low in order to offset the impact from unexpected shocks, a top central bank official said.

“As the Committee has made clear, there are limits to the extent to which above-target inflation can be tolerated. These limits depend, inter alia, on what is driving the inflation overshoot, on the impact on inflation expectations, and on the scale of the output gap.

"The exchange rate shock has made it more difficult for policy to follow the natural rate,” Monetary Policy Committee member Sir Jon Cunliffe said in remarks prepared for a speech at the University of Manchester.

However, the depreciation in the exchange rate had increased the size of the trade-offs which went hand-in-hand with keeping rates low for such an extended period, the policy-maker said.

Nevertheless, in his opinion Bank was right to justify its exceptionally loose monetary policy, eights years on from the financial crisis, by reference to the so-called 'natural' rate of interest.

Indeed, he conceded that when rates are at absolutely low levels the tools deployed by the BoE to offset shocks to the economy can have more complex effects on the financial sector and the prices of financial assets.

In a secular period of low interest rates other authorities had instruments which were better placed to address challenges such as raising the rate of growth in productivity and the distributional wealth effects of policy.

“The answers to these challenges are not simple,” Cunliffe concluded.

“Structural change to raise productivity can be very difficult; it often means there will be losers and winners. Likewise, fiscal policy needs to balance public spending with sustainability through time.”

Cunliffe defined the 'natural' rate of interest as the short-term rate needed to offset shocks to the economy, as opposed to the trend real rate, with the latter being a longer-term measure which balances demand for investment with the supply of savings.

The natural interest rate had risen from its 2012 post-crisis trough but was still likely to be negative, he said.