Cut interest rates immediately to avoid compounding recent mistakes, says IEA’s SMPC

A group of independent economists that shadow the Bank of England has called for interest rates to be cut. This comes amid uncertainty about whether the Bank’s Monetary Policy Committee (MPC) will cut interest rates this week (Thursday November 7th) for only the second time since March 2020.

The Shadow Monetary Policy Committee, hosted by the free market think tank the Institute of Economic Affairs, has warned that monetary policy has not responded to the downward trend in inflation and low monetary growth and has become a drag on the UK’s already modest GDP growth.

Starting in 2021, the SMPC made one of the earliest calls for the Bank to start raising interest rates and criticised the Bank’s forecasts for understating the threat of inflation. For more than a year, however, the SMPC has been warning that the Bank has raised interest rates too far and held them for too long.

Growth in the UK’s ‘Broad Money’ (M4) supply has slowed since July 2023, bringing inflation down and reducing credit availability. Bank of England Governor Andrew Bailey recognised recently that inflation has fallen “faster than expected”. The SMPC warned that the Bank’s tight monetary policy risks inflation continuing to undershoot its target and GDP growth being slower than necessary.

With inflation close to the Bank of England’s 2% target and UK gilt yields implying a long term average interest rate of around 4.25%, members questioned what the MPC was trying to achieve by keeping Bank Rate at 5%. The SMPC unanimously agreed with bringing Bank Rate into line with long-term real interest rates but disagreed on how quickly to proceed.

A number of SMPC members felt that the opportunity to avoid a significant undershoot of the inflation target has already passed, and that on a forwards-looking basis monetary growth, though still too low, is not dramatically so, meaning that a more incremental approach of cutting Bank Rate by 25 or 50 basis points was enough. Two members felt that there remained merit in more drastic action to mitigate the effects of a sustained error by the Bank in keeping rates too high for too long, and favoured an immediate 75 basis points cut.

Andrew Lilico, Chair of the Shadow Monetary Policy Committee and IEA Economics Fellow, said:
“The Bank is now claiming that inflation consistently undershooting its expectations is a surprise as inflation has fallen, just as it claimed it was a surprise when inflation consistently overshot the Bank’s expectations as it rose. Neither should have been a surprise and neither was a surprise to the Shadow MPC. The Bank should learn its lesson and pay more attention to movements in the money supply when such movements are large. For now, it should cut rates immediately to bring them back closer to a more neutral level. Tight policy serves no purpose at present.”