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BoE risks blow to credibility over rate stance, warns Sentance – 1939

  • 14 October 2010

In a speech to the British American Business Council , Sentance, a member of the BoE's Monetary Policy Committee (MPC), again argued for the Bank to begin a ‘gradual adjustment of monetary policy".

He believes the improvement in the UK economy seen over the last year and persist above – target inflation means it is time to begin withdrawing the "very substantial" level of monetary stimulus that has already been provided to the economy.

Sentance fears a continuation of current policy will result in inflation becoming embedded, forcing sharper and faster rises in rates.

He warns: "If we continue to experience above-target inflation, while the MPC sets policy to head off the opposite risk – of deflation – confidence in the inflation target and the credibility of the MPC risk being eroded….

"The longer the period of above-target inflation goes on without any policy response, the greater this risk becomes."

He worries that confidence in policymakers charged with maintaining low and stable inflation could have a knock-on effect on inflation expectations across financial markets, among the business community and the public.

The Bank appears to already have lost its credentials on inflation among some public members, with Daily Telegraph reader morgan complaining: "Credibility? What a joke when their inflation target index (CPI) can hide a 6% rise in the cost of essentials by some spurious, incredible and frankly unbelievable 30% fall in the cost of air travel.

Morgan adds: "Most people know real inflation in the UK is at least 5%-10%  The MPC, the CPI all just propaganda to justify a perverse and unfair monetary policy."

Sentance's position as the lone hawk on the MPC contrast sharply with that of fellow member Adam Posen who has been calling for yet more stimulus to be provided to the economy on worries about deflation and significantly below-target inflation 12-24 months out.

While Sentance believes the economy is now strong enough to cope with gradual tightening of monetary policy, Posen has been raising the spectre of low growth and high unemployment, something Japan had to contend with throughout the 1990s.

Azad Zangana, European economist at Schroders, says Sentance's latest salvo on rate policy should be seen as a warning against reading too much into single weak data points both in the US and the UK.

Zangana says: "Sentance is clearly confident the global recovery is underway, but is particularly concerned that there is less spare capacity in the UK economy, which means that deflationary pressure may be far weaker than the majority of the MPC believe.

"Though he expects raising interest rates will cause some pain for borrowers, he also believes that many savers who rely on interest payments for their incomes, would benefit, and potentially boost confidence in the recovery."

Given Sentance's recent votes – he has been voting for tighter policy since June – the tone of his latest "confident" comments comes as little surprise to Zangana.

Zangana adds: "Sentance has so far failed to persuade any other MPC member to join him in voting for tighter policy and our sense is that Adam Posen may have similarly been unsuccessful in attracting supporters.

"We continue to expect next-week's MPC minutes to show a three-way split at the October meeting, and suspect that this pattern may be evident for some time. "

In a recent interview with Mindful Money, Zangana argued that further loosening of policy via quantitative easing could not be justified both in terms of how the BoE went about calculating how much QE was needed originally and on the basis of the UK's economic performance since that injection.

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