Maintain course amid structural uncertainty: Huw Pill’s monetary policy perspective
At the start of November, the Bank of England’s Monetary Policy Committee (MPC) voted 5-4 to maintain its base rate at 4% – signalling that restrictive policy is reducing inflationary pressures and delivering price stability.
At our recent London event, Huw Pill – Chief Economist at the Bank of England and MPC member – joined Alain Durré, our European Chief Economist, and Sylwia Hubar, UK Economist, to discuss diverging views in the MPC and his appraoch to monetary policy in uncertain times.
The decision to maintain rate levels comes as underlying inflationary pressures continue to ease, however rates of wage growth and service inflation must continue decreasing before the MPC is confident forecasting a return to the 2% inflation target. Rate decisions fit within broader internal debates around why headline inflation persists at 3.8% as divisions over causes drive closely contested policy votes.
Pill explained that MPC votes are split along differing interpretations of the UK’s normal dynamics. The more dovish perspective attributes inflation to temporary supply-side disruptions (such as the pandemic and invasion of Ukraine), expected to fade over the coming year.
The hawkish view argues that successive shocks have altered the structural backdrop for price and wage setting. While Pill recognises that temporary factors are still influencing headline inflation, he stressed the importance of acknowledging longer-term shifts in the economy that may lead to more persistent inflation. He also stressed that he is open to both argumentations.
Finding signal in the noise
The apprehension to be overly decisive is understandable. The Bank of England’s (BoE) failure to forecast inflation – and the Bernanke review into its modelling and communicating risk – are shaping the MPC’s approach to strategy. Pill highlighted a renewed commitment to adaptability and more rigorous internal processes, comparing visible policy changes to the tip of an iceberg, with far greater volume of incremental adjustments happening beneath the surface.
A key part of this evolution is improving how MPC members select and weigh economic data. Because monetary policy takes time to feed through to the economy, short-term data can be noisy and potentially misleading. Pill believes it is essential to maintain a medium-term orientation to filter the signal from the noise and gain a better understanding of the underlying economic trends. This view focuses on structural changes in price setting and the labour market, such as the level of slack in the economy.
Monetary policy takes time to feed through to the economy, short-term data can be noisy and potentially misleading.
While the outlook remains in the medium term, the BoE’s own micro-data surveys supplement analysis, gauging changes in wage and price setting behaviour. Late-cycle indicators are another important real-time benchmark when the neutral interest rate is uncertain. Reading a broader set of indicators allows for greater understanding of what is driving high levels of domestic inflation. Presenting a consistent outlook depends on constructing a narrative that communicates the MPC’s strategy as a coherent signal to the markets.
Rate-setting: gradualism or activism?
Scepticism over short-term microeconomic data splits MPC votes along a second axis, concerning the pace and magnitude of interest rate decisions.
For Pill, where an MPC member falls along this axis is determined by how much they think they know about the neutral rate of interest (r*). The gradualist approach is cautious of persisting uncertainty over the r* and follows the Brainard principle – when the effects of policy are uncertain, moderate the pace of transmission.
Those with greater confidence in their assessment of r* and economic potential advocate for an active approach, making greater rapid adjustments to move to a neutral rate more quickly. Pill prefers gradualism, sceptical of placing weight on empirical estimates of the r*. Instead of looking at levels, his focus is on “feeling your way” by focusing on changes in the level of the interest rate associated with changes in growth and inflation.
Fundamentally, this is a safer position, Pill explains. In the active approach, if you think you are being restrictive, when you are in fact being accommodative, there is a great risk of fuelling inflation.
Balance sheet policy: a predictable path for QT
Alongside their rate-setting decisions, central banks are reevaluating their liquidity management by adjusting Quantitative Tightening (QT) levels. The Federal Reserve decided to end QT at the start of December, while the ECB intends to reconsider its levels in the coming year. The BoE is slowing QT levels from £100bn per year to £70bn per year.
The BoE’s position is distinct from the other central banks because the Quantitative easing that took place in 2020 was done in line with the structure of government public debt, spread across maturity buckets.
Pill explained how the BoE’s position is distinct from the other central banks because the Quantitative easing that took place in 2020 was done in line with the structure of government public debt, spread across maturity buckets. Running these debts carries a large and inflated balance sheet; to remedy this the BoE intends to conduct sales in a steady, predictable, and gradual way to balance the portfolio without disturbing markets or creating expectation of a more active approach to QT policy.
This reflects a shift towards a steadier state balance sheet, moving towards a demand driven approach to liquidity using short-term repos and indexed long-term repos, putting the BoE’s approach closer to that of the ECB than the Fed.
Although QT is an important tool, Pill stressed that it should not be debated on a meeting-by-meeting basis to avoid the risk of creating noise in the system; rate setting remains the MPC’s active monetary policy.
The way ahead
Looking ahead to the MPC’s December meeting, members will once again vote on whether or not to reduce the base rate by 25 basis points. The move will hinge on underlying price and wage pressures continuing to ease while demand grows – guided by medium-term assessments of underlying inflation dynamics instead of a target neutral rate.
The government’s Autumn Budget and broader geopolitical risks will weigh on the magnitude and pace of rate setting. In the long term, the MPC expects to maintain a course towards its 2% inflation target as disinflationary trends continue.
