UPDATE 2-BoE's Miles says rates unlikely to return to pre-crisis average
LONDON Feb 27 (Reuters) - The financial crisis has transformed the way people view risk so much that Bank of England interest rates are likely to be below their historical average for "a sustained period", a BoE policymaker said on Thursday.
David Miles, a member of the BoE's Monetary Policy Committee, said the "new normal" for rates was likely to reflect how households, firms and investors attach a higher probability to financial crises and economic downturns than in the past.
"The new normal for monetary policy will probably involve setting bank rates on average at a lower level than before the crisis," Miles said in a speech in London.
"One factor behind the recent sharp fall in real yields - changing perceptions of the level of risk in the world - is likely to be persistent."
The BoE has linked its record-low interest rates to the amount of spare capacity in the economy, and policymakers have stressed the economy will not be weaned off the stimulus of ultra-low borrowing costs quickly.
Despite a recent resurgence, Britain's economy is still 1.4 percent smaller than its pre-financial crisis peak in 2008 - a worse situation than almost all other big advanced economies.
Miles said short-term factors, like the government's drive to cut the budget deficit and weak euro zone growth, were also reasons rates were unlikely to return to their pre-crisis average. But the fundamental change in perceptions of risk would have a lasting effect, Miles said in his speech in London.
"I am not arguing that the neutral level of policy rate will never be 5 percent again, but I think that for a sustained period there are reasons to think that it might be lower than that," he said.
The experience of events like the financial crisis - once thought nearly inconceivable - has made low-risk assets more attractive, driving down the real risk-free interest rate, Miles said.
That in turn should help to reduce the BoE's neutral level of its interest rate - one that would reflect inflation a little under the Bank's 2.0 percent target and at which slack in the economy would be small.
In a newspaper interview published earlier on Thursday, Miles said the greater difference between mortgage rates and the BoE's rate would also keep a lid on the central bank's official lending rates.
He also said that if and when the time comes for the BoE to start selling its 375 billion pounds ($625 billion) of government bonds, accumulated through its quantitative easing stimulus, that would probably not have a big effect on the BoE's neutral policy rate.
He cited research that suggested central banks will be able to unwind their vast bond purchases when market conditions are more normal without a big impact on asset prices and the real economy.
"The bottom line is that I believe the neutral level of bank rate is likely to be quite insensitive to decisions on when to sell government bonds," he said.