Monetary Policy

The BoE should aim for interest rates of 3 to 4 per cent by mid-2023

Commenting on the Bank of England Monetary Policy Committee’s decision to raise interest rates to 2.25 per cent, Julian Jessop, Economics Fellow at free market think tank the Institute of Economic Affairs, said:

“The Bank of England MPC’s decision to raise interest rates by just half a percentage point, when many other central banks have switched to three-quarter point moves, is another missed opportunity to regain credibility. Nonetheless, there are some mitigating factors.

“First, many were worried that a smaller move might add to the downward pressure on the pound. However, the currency markets have reacted calmly, presumably taking the view that more aggressive tightening would have hit the UK economy hard.

“Second, the MPC confirmed that the Bank will press ahead with the gradual sales of UK government bonds (‘gilts’) that had been bought under the policy of ‘quantitative easing’ (QE). This is significant, both because it is another form of monetary tightening, and because there had been some speculation that the Bank would delay the start of active ‘quantitative tightening’ (QT) in order to help the government to finance the additional borrowing. That would have sent a terrible signal.

“Third, the MPC clearly left the door open for further increases in interest rates, and soon. Indeed, three of the nine members did vote for a three-quarter point hike. The statement hinted that others wanted a little more time to assess the impact of the Energy Price Guarantee, and the upcoming ‘Growth Plan’, on both demand and inflation, but that more action will follow in November.

“However, even at the new level of 2.25 per cent, UK interest rates are still abnormally low and need to rise further to get inflation expectations back down and return inflation to the 2 per cent target again. No-one is suggesting that the Bank can do anything about global energy prices. But ‘core’ inflation, excluding both energy and food, is now running at around 6 per cent. The extended period of very loose monetary policy has undoubtedly contributed to the cost of living crisis.

“Based on the inflation target of 2 per cent and the new target for economic growth of 2.5 per cent, the ‘new normal’ for nominal interest rates might be in the range of 4 per cent to 5 per cent. The large uncertainties at the moment might justify keeping rates a bit below this range for a while, but the Bank should aim for 3 per cent to 4 per cent by mid-2023.”


Notes to editors

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