By David Barwick – FRANKFURT (Econostream) – The Bank of England may need to act further to support the recovery while containment measures remain in place, Michael Saunders, member of the BOE’s Monetary Policy Committee (MPC), said on Friday.

In a speech for an online webinar, Saunders said the effective lower bound on interest rates for the UK economy was probably a bit less than zero.

‘… monetary policy may need to do more if these downside risks develop, in order to provide a bridge for the economy during the period of restrictions, and to underpin recovery as restrictions ease’, he said.

Although the news regarding vaccines is ‘clearly encouraging’, downside risks remain in connection with the pandemic and related measures; Brexit and how businesses respond; a likely rise in unemployment associated with a decline in household income; balance sheet issues and ‘psychological scarring’, he said.

Noting that the Bank is in the process of considering where its effective lower bound could be and whether taking borrowing costs below zero could make sense, Saunders said that he believed the ELB to be ‘probably a little below zero, provided appropriate mitigations (eg reserve tiering, bank funding scheme) are in place.’

However, the ‘considerable uncertainty’ about where exactly the relevant ELB is situation implies that monetary policy room to manoeuvre is limited, in turn arguing for resolutely countering downside risks out of risk management considerations, he said.

‘If we provide too little stimulus and the economy turns out weaker than expected, the relatively limited extent of monetary policy space implies it would be even harder to return inflation to target, especially if persistent low inflation depresses inflation expectations,’ he said. ‘Hysteresis costs would rise.’

‘Conversely, if we overdo monetary stimulus and the economy recovers faster than expected, this would be a relatively benign outcome’, as the MPC ‘would have ample time and scope to tighten policy again, if needed, before the economy moves into excess demand and inflation becomes established above target.’

‘Provided inflation expectations are well contained, it is better to err on the side of providing too much monetary stimulus rather than too little, in order to underpin prospects for a strong recovery in the economy’, he said.

Uncertainty about the level of the ELB also means additional asset purchases alone could be less effective, he said. There is ‘ample scope’ to increase these, but such an increase would be best ‘accompanied by a cut in Bank Rate (or guidance that such a cut is likely)’, he said.

This is because 5-year yields are slightly below Bank Rate and 10-year yields are around 30-40 basis points, so that buying more assets probably would not by itself reduce yields much, if at all, he said.

Moreover, he said, ‘[i]t is unlikely that the usual type of forward guidance – that tightening is unlikely until various conditions are satisfied – can reduce market rate expectations significantly unless accompanied by expectations of a lower Bank Rate, given that markets already project Bank Rate will be at or below the current level for several years.’

Any further cuts in Bank Rate should be cautious and thus smaller than the usual 25 basis points, he said.