BOE’s Taylor Says Rate Rises Only Needed in Worst-Case Scenario

Alan Taylor, member of the Monetary Policy Committee at the Bank of England Photo by Matt McClain /Photographer: Matt McClain/Bloom

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(Bloomberg) — Only the most pessimistic Iran scenario clearly justifies raising interest rates, according to Bank of England policymaker Alan Taylor, who warned that the UK faces a higher recession risk because of the conflict.

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Speaking at an MNI webinar on Thursday, Taylor said that an “extended hold” could be enough to keep inflation in check if more worrying second-round effects from the energy shock don’t materialize. So far, a weakening jobs market has kept a lid on price pressures, making an inflationary spiral less likely than in 2022.

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“We have a very weak economy being hit by an inflationary supply shock, and there are big trade-offs for us to consider,” Taylor said. “We don’t need to be super reactive now, given how much restrictiveness there is coming already.”

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Taylor, who voted with the 8-1 majority to keep rates unchanged at the April meeting, is one of the Monetary Policy Committee’s most dovish voices. He argued that holding borrowing costs at 3.75% “feels like enough restrictiveness,” as that’s already well above his 3% estimate of the neutral rate at which policy neither stimulates nor weighs on the economy.

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Factoring in the recent tightening of financial conditions, Britain is 100 basis points above neutral, said Taylor, who was calling for faster rate cuts before the Middle East conflict sent energy prices soaring.

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BOE officials have to balance the risk of a new inflationary shock against a weak demand picture ahead of their June policy meeting. Figures Thursday showing the private sector contracting for the first time in over a year, together with softer-than-expected inflation data and a weak labor market, will provide ammunition to those who favor a wait-and-see approach.

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At the April meeting, the BOE replaced its central forecasts with three scenarios for price pressures and energy costs. Taylor pushed back against the idea that the UK is in the worst-case scenario, where inflation rises to 6.2% in early 2027 and stays above the BOE’s 2% target throughout the forecast period, saying that “it doesn’t look like those risks are certain to materialize at all.” 

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Second-round effects won’t show up in the data until later this year, and may only have a large impact on inflation in 2027, he added. In the short-run, Taylor said he’s focusing on firms; pricing power and news from the Middle East. 

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Taylor warned that the UK faces a higher risk of an economic downturn because of the Iran war. He put the likelihood of a recession at as much as 40%, up from about 20% before the conflict erupted. 

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However, he added that whether a more adverse outcome becomes reality hinges on the duration of the Iran war and its impact on global energy flows. 

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“If we don’t have a peace deal, and we just keep on having the war running for weeks and months, then the more likely it becomes that these second-round effects will materialize,” he said.

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