Sentance Says BOE Must Tighten Now to Prevent Tough Moves Later

By Svenja O’Donnell - Feb 25, 2011 7:58 PM 

Bank of England policy maker Andrew Sentance. Photographer: Graham Barclay/Bloomberg

Bank of England policy maker Andrew Sentance said officials must start raising interest rates from a record low “gradually” to prevent being forced to tighten policy too aggressively later.

“We should increase them gradually and slowly if we can,” Sentance said in a speech in London late yesterday called “Ten Good Reasons to Tighten.” “But the risk of delaying interest- rate rises too long is that this gradual approach may cease to be an option in the future.”

Sentance sought this month to raise the key interest rate by a half-point, which would have been the biggest single increase since the bank gained independence in setting monetary policy in 1997. His comments come as a divide among officials deepens over the risks to inflation and growth. Data today from the Office for National Statistics showed the U.K. economy shrank more than initially estimated in the fourth quarter.

Sentance’s reasons for raising rates include the “persistence” of U.K. inflation above the bank’s 2 percent target, global price pressures, the recovery in U.K. demand and signs that companies are passing on costs to customers. A report from the Confederation of British Industry yesterday showed that retail prices are rising at the fastest pace since 1991.

‘Cannot Be Confident’

“If we could be confident that global inflationary pressures would quickly subside, then we might be more comfortable about not adjusting policy in response,” he said. “But we cannot be confident that the current drivers of global inflation will quickly fall back. The upward pressure on global energy and commodity prices shows little sign of abating.”

The pound fell as much as 0.4 percent against the dollar after data showed British gross domestic product dropped 0.6 percent in the fourth quarter from the previous three months, compared with an initial estimate of a 0.5 percent drop.

Sterling was trading at $1.6096, down 0.3 percent, as of 11:57 a.m. in London. The yield on the benchmark 10-year U.K. government bond was up 1 basis point at 3.64 percent.

The fourth-quarter contraction was partly due to the impact of the coldest December in a century, and recent surveys suggest the GDP decline may have been a temporary setback to the recovery. Services returned to growth in January, manufacturing expansion accelerated and retail sales rose more than economists forecast, reports in the past month have shown.

The threat of inflation prompted two others on the Bank of England’s nine-member policy committee to vote for a rate increase, of 25 basis points, this month, minutes of the meeting showed. The majority opted to keep the benchmark unchanged at a record low of 0.5 percent.

‘Sense of Urgency’

Societe Generale SA yesterday brought forward its forecast for the first rate increase to May from August, saying the minutes “reveal a greater sense of urgency.” Brian Hilliard, an economist at SocGen in London, now sees a 25 basis-point increase in May rather than a 50 basis-point move in August.

Sentance is among six U.K. policy makers speaking this week, with Deputy Governor Charles Bean addressing the U.S. Monetary Policy Forum in New York later today.

The bank’s officials have expressed opposing views, with Adam Posen saying on Feb. 22 that price expectations remain “anchored” and the bank must “not be tyrannized by popular fears.” He voted to add 50 billion pounds ($81 billion) to the bank’s 200 billion-pound bond-purchase program this month.

Posen said at an event in Mumbai today he hasn’t changed his view on quantitative easing.

“I don’t see inflation pressure in the U.K.” because wage growth is “going to be very low over the next couple of years,” Posen said.

‘Very Gradual’

David Miles said two days ago that the level of inflation is “deeply worrying.” Nevertheless, he said he agrees with the bank’s forecast for it to slow to the 2 percent goal in 2012 and the outlook warrants a “very gradual” tightening.

U.K. inflation accelerated to 4 percent in January and the central bank forecasts that the rate will rise to about 4.5 percent this year before easing to its target. The projections are based on the market’s view for the key interest rate to rise to 1 percent by the end of this year and 2 percent by end-2012.

“Because there are a number of factors contributing to the recent surge in inflation, it is perhaps not surprising that there is some disagreement about how to respond to it,” Sentance said. Still, it’s “time to change tack and adapt our monetary policy settings to the changed economic climate.”

The BOE minutes hinted at a growing concern within the panel about inflation risks, noting that “of those members not favoring a rise in bank rate, some thought that the case for an increase had nevertheless grown in strength.”

“Since last summer, I have been arguing that we should be raising interest rates to help to limit the rise in inflation and bring it back to target,” Sentance said. “I am pleased to see this view gaining ground in the committee.”

To contact the reporter on this story: Svenja O’Donnell in London at sodonnell@bloomberg.net

To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net