Interest rates are likely to fall from the current 15-year highs in the long run but not to the near-zero levels of the 2010s, the Bank of England’s top economist has said.
Huw Pill said the Monetary Policy Committee (MPC), which sets the base rate which lenders use to decide their interest rates, said rates should probably offset inflation and provide a small return for shareholders.
As inflation gets close to 2% – the target the MPC has been set by the government – rate settlers will look for a new normal, he said.
Where those rates will settle is unknown, though, Pill said, adding that the Bank hopes it can operate in a more stable environment in the future with fewer shocks such as Covid-19 pandemic and the Ukraine war.
‘The way we think about it is the level of interest rates, the level of bank rate, you might think about it as being related to inflation: so it has to cover someone who’s holding a bank deposit … they probably want to be compensated for inflation,’ he said.
‘We’re targeting inflation at 2%. So, you need an interest rate of 2% to cover that. And then, you know, people put their money in the bank to save. They’re expecting some return on that.’
He added: ‘So, you might want to add a little bit, say half a percentage point, one percentage point, to that 2% compensation you need for inflation as a real return.’
That leaves people with an ‘imprecise number’, Pill said.
It is ‘a number that’s below where we are in terms of interest rates, but probably nonetheless higher than the interest rates that we had in the pre-Covid era’.
‘That’s because in the pre-Covid we were still dealing with the fallout of the financial crisis, rather than being restrictive we had to be supportive of the economy.’
Pill added: ‘The situation that created rates at zero pre-Covid was an exceptional situation.’
The MPC last week held interest rates at 5.25%, the second time in a row it has left the base rate unchanged following nearly two years of non-stop rises.
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