January 15, 2020 / 8:49 AM / 10 days ago

Bank of England's Saunders warns of risk of low inflation trap

BANGOR, Northern Ireland (Reuters) - Bank of England interest-rate setter Michael Saunders warned on Wednesday that Britain risks getting stuck in a low-inflation trap if the central bank does not take early action to boost the economy.

FILE PHOTO: A bird flies past The Bank of England in the City of London, Britain, December 12, 2017. REUTERS/Clodagh Kilcoyne

Saunders, one of the two top BoE officials who voted to cut rates in late 2019, said there was a risk that Britain’s economy would be weaker than his colleagues have predicted over the next couple of years.

“If we defer easing near-term and, in the event of persistent economic weakness, face the need for greater easing later on, then risks of a low-inflation trap – which would certainly not be a benign outcome – would rise,” he said.

Saunders remarks came shortly before official figures showed inflation dropped to its lowest in more than three years in December at 1.3%, a bigger fall than any economist had forecast and well below the BoE’s 2% target.

Saunders said it was too early to say if last month’s election had given the economy a boost, but any improvement was likely to be small.

“Remember that the starting point is that the economy has barely grown since early last year. So it could improve a bit, and growth would still be sluggish,” he said, after delivering a speech in Northern Ireland.

“It would take quite a marked bounce in growth in order to lift growth back to potential and to close the spare capacity which seems to have opened up in the last few quarters.”

Britain’s economy ground almost to a halt in late 2019, according to the most recent official data, as uncertainty about the Dec. 12 election and the possibility of a no-deal Brexit shock as soon as Jan. 31 weighed on confidence.

Some surveys have suggested that companies and consumers turned more optimistic after Prime Minister Boris Johnson won a big parliamentary majority, clearing up the outlook on Brexit, at least for now.

But three Monetary Policy Committee members who previously voted to keep rates on hold, including BoE Governor Mark Carney, have said in the last week that a rate cut might be necessary.

Since the latest inflation data, financial markets now price in a greater than 50% chance that the BoE will cut rates this month. BOEWATCH

In his speech, Saunders said there was a case for the BoE to move quickly, although he stressed he was not giving a signal about how he would vote this month.

“With limited monetary policy space, risk management considerations favor a relatively prompt and aggressive response to downside risks at present,” he said

Saunders also sounded a note of caution for the medium-term.

“My own view is that, even if the economy improves slightly from the recent pace, risks for the next year or two are on the side of a more protracted period of sluggish growth than the MPR (Monetary Policy Report) forecast,” he said.

Reporting by David Milliken; Writing by William Schomberg; Editing by Alex Richardson

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