The Bank of England could plunge the UK into a recession by raising rates too far, the former governor Mervyn King has said.
In a broadside a fortnight before Bank officials are due to meet to decide the next step for interest rates, Lord King said the signals from the credit markets in 2021 that indicated inflation was about to rocket were now showing that price growth was about to drop sharply.
Financial markets expect the Bank to increase the base rate from the current level of 5% on 3 August.
In an interview with Merryn Somerset Webb on the Bloomberg podcast Merryn Talks Money, King said officials on the monetary policy committee could tighten monetary policy too far if they pushed for further rate increases, triggering a recession.
He said the central bank had ignored signals from money supply data, which pointed to higher inflation coming out of the pandemic.
The Bank has defended its position, saying it delayed acting to calm inflation, believing the economy would go through a period of weak growth and higher unemployment after the furlough scheme ended.
The former governor’s comments add to concerns about the Bank’s most aggressive series of rate rises in three decades and the impact it is having on the economy. Mortgage rates have risen sharply and some economists have predicted unemployment could increase next year as corporate bankruptcies rise and job vacancies fall.
Money supply economists claim to have predicted the steep rise in inflation before it jumped to more than 10% in 2022. They have warned that a contraction in the supply of money to consumers and businesses after 13 consecutive increases in interest rates will mean inflation reverses quickly without the need for further action.
King said: “The risk is that having ignored money when inflation was rising, they’re now ignoring money when inflation is actually about to fall. What we could see, therefore, is a mistake in both directions over a period of three or four years.
“If they carry on for the next six months or so tightening monetary policy, it could well be that they generate both a recession as well as a sharp fall in inflation.”
The Bank for International Settlements, which advises central bankers from its headquarters in Basel, and the International Monetary Fund have urged the Bank of England, the US Federal Reserve and the European Central Bank to increase interest rates and maintain them at high levels until they can safely claim that inflation has dropped to the target rate of 2%.
after newsletter promotion
After sharply increasing during 2020 and early 2021, money supply growth in the UK has slumped and was flat in May, the latest available data shows. For monetarists, growth and inflation are a function of the quantity of money in circulation and its velocity – the number of times it changes hands.
Even so, the Bank increased its base rate by half a percentage point to 5% last month after signs that price and wage pressures were proving much stickier than expected. Data on Wednesday showed that inflation, as measured by the consumer prices index, is finally slowing, to 7.9% in June from 8.7% in May.
King’s criticism follows similar comments by the Bank of England’s former chief economist Andy Haldane, who argued for a sharp increase in borrowing costs in 2021, before saying in April that the central bank had gone far enough.
