Below is the transcript of an exclusive CNBC interview with Michael Saunders, Member of the Monetary Policy Committee at the Bank of England.
JB: Michael, before we get into the nitty gritty of Brexit – I know it’s a favourite topic of discussion – I actually want to talk about you and your own voting history. So, thank you very much for joining us on this show this morning…
MS: Thanks for inviting me…
JB: What I find interesting is that for ever since March you’ve been calling for a hike, and this is also coinciding with the weakest growth the UK has seen in about five years’ time. We’re pointing to an annualised growth of about 1.2 per cent for the first quarter. Why have you been calling for a hike?
MS: Let’s give a bit of context to this, right. So after the recession the UK had plenty of spare capacity, unemployment was high, there was lots of underemployment, and that was reflected in in weak pay growth and generally weak domestic cost pressures. Now after six or seven years of economic growth, steady growth, a lot of that spare capacity has been used up, the jobless rate is the lowest in more than 40 years, underemployment has fallen significantly and wage growth is gradually picking up. It’s not too strong yet, right, but we’ve gone through a period in which pay growth, domestic cost growth was too low, to one now where it’s more or less consistent with the inflation target. Now, to be sure as you said the Office for National Statistics reported that growth was soft in Q1 in terms of gross domestic product, GDP, but I think quite a lot of that weakness was probably erratic or temporary, reflecting the adverse effects from the weather that we saw in late February early March, remember the heavy snow – the Beast from the East – and that affected retailing, construction, affected manufacturing as well with goods not being shipped around as much as usual, inventories ending up in the wrong place, and the ripple effects of that seem to have hit growth in March, perhaps even in some sectors in early April, but of course that effect is temporary – the underlying picture is that the economy looks like it’s continuing to grow at a modest but steady pace, similar to the average of the last couple of years.
JB: But we’re still getting the data that will confirm whether or not that actually serves as a temporary phenomenon, the UK economy, and whether or not things really will pick up. In Q2 we’ve got a good amount of data coming up in the next couple of weeks. Let me ask you what would cause you to change your opinion on whether or not the economy can withstand another hike here? Where’s the downside risk going to come from?
MS: So I would say there are two key things which I’m focussed on: the first one is, is the picture of steady growth to which you see evidence in the business surveys and the labor market data, is that on track? So far in the second quarter we’ve seen the areas of weakness in consumer spending, in retail sales, consumer credit, mortgage approvals, many of those have reversed and so that Q2 rebound looks like it’s on track but of course there will be more data to come through. The other issue is is the pickup in domestic cost growth and pay growth still coming through? And again, so far the evidence is consistent with that, but of course that’s a thing we want to keep an eye on…
JB: But recently we’ve seen wages moderating a little bit as well. Is that going to pose somewhat of a risk to your view?
MS: I think that you have to be careful not to sort of over interpret things like three month annualised on the three months previous average earnings growth. The numbers can be a little bit volatile, you do get changes in the composition of the workforce, which means that those shorter term growth rates can move around in a random kind of way. The big picture is that if you look at private sector underlying earnings, that is ex-bonuses, is picked up from about 2 per cent year to year a year ago to about 3 per cent year-to-year now. I stress that’s not too strong, right, but 2 per cent that was consistent with over time and inflation undershoot, pay growth where it is, perhaps even a little bit higher is ok in terms of keeping inflation on target over time but I wouldn’t want to see us sustain further upturn in pay growth unless it’s also come from by significantly higher productivity growth.
JB: Are other members on the MPC buying into this view as well? It comes as a bit of a surprise to the market that the last meeting that Andy Haldane, the chief economist also joined you in voting for a hike. So we have three dissenters now on the committee, can we interpret that the differences are narrowing between various members?
MS: I I think we take decisions from meeting to meeting, right, but those two things which I’ve talked about – the growth outlook, is the rebound on track and is the tightening in the labor market feeding through to pay growth – those are two issues that which I think all are very much focussed on. Now, as to whether we form a consensus one way or another I suspect that will depend on how the data comes through.
JB: How closely are the Bank of England watching the moves on currency, because again we’ve had another depreciation of sterling here, we’re trading at a seven month low versus the US dollar and the last time this happened, perhaps not as significant the move now isn’t as significant as it was last time around, but it’s sufficiently curtailed the Bank of England’s ability to meet the inflation targets – so, are you watching this move now in sterling and perhaps if this move continues and the pound continues to slide it could pose somewhat of an issue with us achieving that inflation objective?
MS: We certainly take currency movements into account in our inflation forecast, of course right we just assume that the exchange rate will stay more or less as to where it is and that feeds through mechanically in to trends and import prices and so forth. But I think in terms of setting monetary policy our focus is much more on domestic cost and capacity growth rather than trying to offset any swings in imported inflation; those matter to an extent but the domestic cost side is probably of greater importance.
JB: When you think about the neutral rate and this cycle, where do you see that ending up roughly?
MS: Significantly lower than it used to be. Look, if you go back to the pre-crisis period, from 1997 to 2007, the Bank of England’s policy rate, bank rate, averaged about 5 per cent, three and a half was low, 6, six and a half was high, 5 was about neutral. A neutral interest rate now is significantly lower than it was previously, and that’s partly to do with demographics, aging population, lower productivity growth, also shifts in fiscal policy, and wider credit spreads. Now, financial markets for what it’s worth suggest that a neutral interest rate is about 2 in nominal terms – in other words, about zero in real terms. And without wishing to endorse that too strongly – maybe that’s a reasonable benchmark for the moment with some uncertainty around it.
JB: And is that one of the reasons why again the Bank of England decided to change the level at which it would start reducing its balance sheet from 2 per cent to 1 and a half per cent – was that one of the factors that played into your assessment?
MS: This is to do with the question of where the effect is zero bound on where the bank rate is. If you go back slightly more than two years ago when bank rate was 50 basis points, the Bank of England’s view then was that 50 basis points was the effective lower bound, that it would be counterproductive to go below that. Hence in order to be able to cut interest rates significantly in the event that the economy were to weaken you would want, you wouldn’t want to start to unwind QE until it got 150 basis points in downside on bank rates which therefore set 2 per cent as a threshold for QE unwind. Since then time has moved on the bank cut rates to 0.25 per cent in the aftermath of the Brexit vote, there’s the TFS, the Term Funding Scheme, in place. We now think that the effect of zero bound is probably is very close to zero so effective lower bound goes from 50 to close to zero, the threshold for QE unwind comes down by a similar 50 basis points, from about 2 per cent to about 1 and a half per cent.
JB: Alright, Michael, we will continue this conversation shortly after this break.
PART 2
JB: I am happy to say that still with me is Michael Saunders, Member of the MPC from the Bank of England. Michael, thank you as ever for being with us on the show. We were just discussing a little bit about where the Bank of England could get to with R-star - I’ve got to ask you this: the market is pricing in around 30 basis points of hikes, a little bit more than one hike over the next 12 months. Does that sound a little too cautious to you?
MS: If the economy plays out as I expect it, it may be that rates need to go up a little faster than that. A sort of faster return to a neutral rates, and my expectation condition on Brexit unfolding in a sort of smooth and gradual way is that the economy will continue to grow at around the pace that we’ve seen over the last couple of years, one and a half to two per cent, I expect the jobless rate will fall a little further and pay growth will pick up a bit. And against that background I think that yes rates might need to rise a little faster, and I stress that’s about an earlier return to a neutral rate. I think the neutral rate is significantly lower than it used to be. And even if rates were to rise a little faster than markets price in I think that the general picture is still limited and gradual, not too far, and not too fast.
JB: Which is defined as roughly twice a year?
MS: I don’t think you can define it as that’s precisely a rule. Look, if you go back to the pre-crisis period, the Bank of England made four tightening cycles from ’97 to ’07, on average interest rates rose by about 100 basis points, one percentage point over roughly 9 months, so there’s a lot of tightening paths which would qualify as gradual compared to that. So, relatively gradual because we have no great urgency and limited in the sense that neutral interest rate is significantly lower than it used to be.
JB: Michael, you say that you have no great urgency but then we also haven’t discussed Brexit and and one of the key risks highlighted by the Financial Stability Report was that of course was to do with Brexit. The market again is pricing it at a decent chance of the MPC hiking in August – my question to you is why hike in August when we still don’t have clarity and won’t have clarity on what this final trading agreement is going to look like until at least October?
MS: So what we do on Brexit is we take a range of possible long-run outcomes and work out their average effects on the economy over time and then assume that the economy adjusts in a gradual weight of that. I say what’s more important is what what are businesses doing, and so far the pace of the economy and what we’ve seen in the business surveys suggest that businesses are doing more or less the same kind of thing. And so far it looks to me as if the economy’s underlying path, once you strip out weather effects and so forth, is that growth is probably a little bit above potential, we’re using up spare capacity. And if that’s right then we don’t need as much stimulus as we do now. But it’s important also to realise that the monetary policy implications of different Brexit outcomes are not automatic. Let us assume, just for the sake of argument, that we would have a very soft Brexit – I’m not making a pre-judgement, just as an illustration – it might well be that business confidence would rise, employment and investment intentions might be a little stronger, but it would also be possible because financial markets are making a judgement on these things as well, it would also be possible that the currency could appreciate, and so you’d have different moving parts in the growth and inflation outlook, and the monetary policy implications of that could go either way.
JB: How closely are you talking to businesses, because in the last week alone we’ve heard the likes of Volkswagen, we’ve heard of Airbus and these are big companies warning that unless there’s some clarity on Brexit plans they will have to make significant investment decisions away from the UK. So, how closely are you in contact with some of these key names and key international companies?
MS: All of the MPC, myself included, we spend a lot of time talking to businesses in all sectors and all regions of the UK. And, but what I would say is that if you had the current conditions – high return on capital, relatively low cost of capital, high capacity use – you would normally under these conditions expect investment would be growing very strongly: 8, 10 per cent year-to-year. Now, we’re not getting that sort of big cyclical investment surge and it’s clear that Brexit is dampening investment intentions compared to what we would otherwise have. But overall investment has grown over the last couple of years at a modest pace, and what we see in surveys of firms’ investment intentions suggest that we will have that, so not the stronger investment which we could have had but equally not an outright drop on a sustained basis.
JB: Assuming we don’t continue to get warnings like that in the near future though, so you must presumably be keeping a close eye on that, on the language that is coming out of those types of companies?
MS: Yes of course but we we pay attention to what all firms are saying right, so not just the ones which you see in the headlines, but by trying to talk to a wide range of firms across all sectors and all regions we do try to get the the views of businesses.
JB: Just looking at the trade numbers in the UK, the UK has actually posted a record goods trade deficit, ex-oil, with the rest of the world, so the corollary of that of course is that the UK is drove must be somewhat underpinned by growth in the rest of the world and the pick up in emerging markets. Are you concerned that with some of the slowdown that’s going on in EM potentially that this could also negatively impact UK growth prospects as well?
MS: It’s certainly the case that net trade and export growth has been a major driver of UK growth over the last year, in the period since sterling’s depreciation, and in our forecasts we’re expecting that exports will continue to grow strongly for this year. There’s something of a puzzle here right, the surveys of exporters generally look pretty positive, and we saw that for example in yesterday’s PMI. The official trade data from the ONS have shown export volumes being quite weak in the early part of this year. Now so far I’m inclined to put more weight on the surveys and expect the trade data to catch up but that’s the thing where we’ve got to sort of wait and see the evidence come through. More broadly the UK is very sensitive to swings in global growth, right, and if global growth were to slow significantly obviously all else equal that would be a negative for UK growth. So far what we see in the surveys of exports is generally still pretty positive.
JB: How do you think a so-called global trade war would play into that? I mean of course this is the other big theme that we’ve discussed on the show and in financial markets and that is the potential retaliatory tit-for-tat trade war going on between the US and the rest of the world, and of course the UK will be caught in the cross-winds because it is an open economy. Does that concern you as well, the threat of more trade tariffs on a global trading level?
MS: In broad terms, freer trade has been a big driver of global prosperity, global growth over the last 25 years or so. And the UK has gained enormously in terms of economic growth from that. The UK’s a very globalised economy, large exporter, and also large foreign direct investment in the UK. And so swings in global growth have a big effect on the UK, if you were to get a retreat from freer global trade that also could affect the UK growth outlook. But again so far in the surveys of export orders it looks as if what we’ve seen externally is not significantly, not having a major effect, on UK export growth. But clearly it’s a thing which we are keeping a close eye on.
JB: How closely do the Bank of England watch what the Fed are doing? Because the Fed are more than half way through a hiking cycle, the economy is still looking pretty robust, and in fact all of the hikes have been very readily absorbed by financial markets there and also by consumers. So does that give you confidence perhaps that the Bank of England once they start a full hiking trajectory could get to similar outcome without creating too many side-effects?
MS: I, I, I would say that the Fed make their decisions based on their economic conditions, we make our decisions based on ours so there’s certainly no sense in which we are obliged to or feel under pressure to follow the Fed. I do think it’s, I think the Fed’s experience in terms of the unwind of asset purchases has been quite interesting, with a very gradual and predictable pace of unwinds and so far the market implications for that seem to have been quite limited. Now I do do think that that’s quite an interesting thing to have seen.
JB: Finally, just one last point. Again this is a red warning that came from the Financial Stability Report on the validity of contracts and clearing for financial services post Brexit. Again, time is running out, we’ve only got about nine ten months until the full Brexit. When would you need to get clarity on what happens to those contracts on the trading side for financial services before you would take it into consideration, it would significantly effect monetary policy outlook?
MS: Now I have to say this is something which I’m not an expert on, the governor has talked about this so I would refer you back to his comments on that. Sorry.
JB: Alright, Michael fair enough – thank you very much for joining us today.
ENDS
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