Low Rates May Risk More Severe Downturns,  BOE Deputy Governor Says

(Bloomberg) -- A prolonged period of low interest rates risks making economic downturns more severe, according to Bank of England deputy governor Jon Cunliffe.

Speaking in London on Monday, Cunliffe said the drop in long-term market rates in developed economies partly reflected an over-pessimism about long-term prospects, and was also part of a structural trend. One “challenge of low for longer for financial stability” is “the risk that in such an environment, economic downturns will on average be more severe,” he said.

“Low for long makes demand management of the economy more difficult in downturns, reducing the space for monetary policy easing with conventional tools” Cunliffe said. “This is because, for a given inflation target and with the reduction in long-run real rates, policy rates are closer to their effective lower bound.”

He also said the environment can also lead to “greater risk taking and less resilience in the financial sector.”

In the speech that mainly focused on the impact of low interest rates on financial stability, Cunliffe didn’t talk directly about Brexit or short-term BOE policy, although he reiterated the bank’s mantra that “any future increases in rates will be limited.” He added that monetary policy “is not powerless at the effective lower bound.”

The speech comes amid growing signs of a split on the BOE’s Monetary Policy Committee over the correct way to react to a potential Brexit extension. While hopes of a deal have increased in recent days, the next 48 hours will be crucial if prime minister Boris Johnson is to avoid being forced to delay Britain’s departure beyond the Oct. 31 deadline, which he has vowed to meet.

Deputy Governor Dave Ramsden said in an interview with the Daily Telegraph this week that there was “less of a case for a more accommodative monetary position” amid the “entrenched uncertainty” another delay would bring. That put him at odds with former hawk Michael Saunders, who said in a speech last month that the BOE may need to cut rates even if the U.K. avoids a no-deal exit, and stressed that the uncertainty shouldn’t be a “recipe for policy inertia.”

More policy makers could weigh in this week, with Gertjan Vlieghe and Governor Mark Carney both due to speak on Tuesday. Attention will then turn to Washington, where Carney, along with Cunliffe, will appear at the International Monetary Fund‘s annual meeting.

To contact the reporter on this story: David Goodman in London at dgoodman28@bloomberg.net

To contact the editors responsible for this story: Paul Gordon at pgordon6@bloomberg.net, Brian Swint

©2019 Bloomberg L.P.