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The Bank of England may need to slow the pace of interest rate cuts if UK consumers become less worried about saving for a rainy day and start spending more freely, a senior policymaker said on Wednesday.
Megan Greene, an external member of the BoE’s Monetary Policy Committee, said it was surprising that consumption was much weaker in the UK than in other advanced economies, remaining below its pre-pandemic level even though strong wage growth had restored households’ purchasing power.
Understanding why spending was so sluggish would be “crucial” in judging how long monetary policy should remain restrictive, she said in a speech in Newcastle. This was because the MPC’s outlook for growth and inflation rested on two assumptions, “firms don’t feel they can pass on higher costs this year, and consumption should pick up”.
Greene said one possible explanation was that households spooked by the cost of living crisis, higher interest rates and softer jobs market were putting wage gains into a “rainy day piggy bank” and cutting big-ticket purchases of new cars or washing machines, although they were still spending on leisure.
A second explanation was that higher interest rates — the BoE’s benchmark rate stands at 5 per cent — were having their intended effect and encouraging people to borrow less and save more while higher returns were available.
Finally, there could also be households who were now spending a bigger share of their income on mortgage repayments, or were putting money away in anticipation of refinancing mortgages at higher rates, she said.
If people became less worried about the future, or less keen to save as interest rates came down, consumption could bounce back faster than the MPC expected, making it easier for companies to raise prices, Greene said.
“This would necessitate a restrictive monetary policy for even longer to bring inflation sustainably to target,” she said, while noting that higher mortgage costs could weigh on consumption for longer.
Greene’s speech came a week after the MPC voted to hold interest rates at 5 per cent, despite meeting in the wake of the 0.5 percentage point cut by the US Federal Reserve, and quarter-point move by the European Central Bank.
Although Greene made no reference to the political context, bleak warnings of fiscal retrenchment from the new government also appear to have hit household confidence, with consumer confidence falling sharply in September.
The BoE last week signalled that it could lower borrowing costs again as soon as November, following a quarter-point cut in August, but said it would reduce rates “gradually over time” to ensure inflation stayed low.
Inflation held steady at 2.2 per cent in August, according to official data, above the central bank’s 2 per cent target but well below a surge that took it above 11 per cent in 2022.
Governor Andrew Bailey reinforced the BoE’s message this week, telling the Kent Messenger that while rates would continue to come down “gradually”, he did not expect them to settle at the historically low levels they had reached during the pandemic.
