Sentance: Act now on rates or risk sharp hike in future

Interest rates must be steadily increased now to avoid a sudden and heavier rise down the line that would “jolt” the recovery, Bank of England monetary policy committee member Andrew Sentance told City A.M. in an exclusive interview.

If the inflation “genie” comes out of the bottle, he said, the UK would face a “hard and painful job” of reasserting price stability.

“The longer we delay [monetary tightening] the more there is a risk that interest rate rises when they come will have to be larger, and then there will be a bigger risk of a shock to confidence,” Sentance said.

Yet the Bank’s rate setting committee is starting to move closer to Sentance’s view that inflation must be tackled with a small but immediate rise in rates, he suggested. “The minutes of our last two meetings reflect a growing concern about inflationary pressures that are coming through,” he said. In January Martin Weale joined Sentance in voting for a 0.25 per cent rise in rates.

Sentance added that the Bank’s policy of quantitative easing (QE) -- currently paused at £200bn – could be reversed through gilt sales. “If we start raising interest rates over a period of time then we probably need to review whether the amount of stimulus being provided by QE is also appropriate,” he revealed.

The Bank’s inflation report, out this month, is “a chance for the committee to update its overall assessment” of the threat from price pressures, he said.

Rates were only dragged so low “to combat worries about deflation and recession in the middle of 2009,” Sentance argued.

Sentance, who will retire as a member of the monetary policy committee (MPC) in May, questioned the group’s track record of predicting inflation. “There’s been a tendency to overestimate the dampening impact of spare capacity, and underestimate the upward pressure from a strong global economy. The argument that we don’t need to raise interest rates seems to rest on [the MPC] continuing to do that.”

The Bank must be careful to retain its “hard won” credibility by keeping inflation in check, he claimed. Consumer price inflation hit 3.7 per cent in December, with Bank governor Mervyn King warning that it could jump as high as five per cent this year.

And economists should heed the “health warning” that came with last week’s shock figures showing a contraction in the economy at the end of 2010, Sentance advised. “The Office for National Statistics (ONS) don’t have very complete information [for December] so anything that they’re saying about that at the moment is very provisional.”

“It’s pretty clear from most people’s experience that economic life was disrupted with the snow -- we saw airports closed and people unable to get to work,” he said, while pointing to business surveys that continue to show a steady economic recovery, such as yesterday’s purchasing managers index which showed British manufacturing hitting a record high of 62.0 in January.

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