The Bank of England (BoE) must raise interest rates more aggressively to avoid a sterling (GBPUSD=X) depreciation against the dollar that would drive inflation higher, according to policy maker Catherine Mann.
In a speech at a Market News International Connect event on Monday, Mann warned the pound could come under pressure in the near term if Threadneedle Street falls behind the Federal Reserve and the European Central Bank in lifting rates.
She also argued UK inflation was likely to prove stronger than thought due to government support packages along with “strong employment, wide-spread bonuses as well as robust wage growth, strong housing values” and accumulated savings over the pandemic.
Mann, an external member of the Monetary Policy Committee (MPC), was part of the defeated minority of three, who voted to increase the Bank rate by 50 basis points at last week’s meeting.
Six members voted for a quarter point increase. BoE's move followed a 0.75% hike from the Federal Reserve a day earlier.
"I voted for a 50 basis point increase at the last MPC meeting," Mann said. "In my view, a more robust policy move, based on both domestic conjuncture and commensurate with the global factor, reduces the risk that domestic inflation already embedded is further boosted by inflation imported via a sterling depreciation."
Catherine L. Mann says changes in interest rates in the US can affect the UK economy. And she explains how that has influenced her thinking on what should happen to interest rates in the UK. https://t.co/RjnUK1Cnwx pic.twitter.com/90inFW7PWu
— Bank of England (@bankofengland) June 20, 2022
The central bank hiked its key rate to 1.25% last Thursday and said it was ready to act "forcefully" if needed to stamp out dangers posed by inflation.
Consumer prices are on course to peak over 11% in October, according to the Bank’s revised forecast.
She added there were signs that the jump in inflation, which hit a 40-year high of 9% in April, was becoming more embedded and persistent, and had more momentum following government support measures for households.
The former global chief economist at Citi stressed the spillovers from the Fed's rates shock on the UK's macroeconomy is "inflationary rather than disinflationary".
She argued the BoE should forget about the long-term economic effects of rate raises for now, and instead look at what they do for sterling.
Mann added: "It is well documented that the global factor is disproportionately associated with US macroeconomic and financial conditions, due to the sheer size of the US economy, the outsized importance of the dollar as a reserve and invoicing currency, and the role of US government securities as safe haven assets. On these bases, too, reigns the importance of Federal Reserve policy."
She argued rates can be raised for now, which would likely boost the pound, and ease inflation by making imports cheaper. The MPC member explained the approach in the chart above, which indicates that the pound could depreciate by 8% over the next four years if the Bank drags its feet on rates.
Mann also hinted at the need for rate cuts following the current monetary tightening cycle.
"I open the door to a policy rate reversal in the medium term when the domestic supports to demand fade and when weakness in external sources of demand bite," she said. "In my view this monetary policy path supports an inflation-output combination superior to that of the historical reaction."