Official UK interest rates will need to rise before any economic recovery is felt on the ground to stave off the risks of an inflationary surge, former Bank of England Deputy Governor John Gieve said. "We've got to hold on to the fact that inflation will be kept low," Gieve said in an interview with the Sunday Times.
"That will require some very difficult decisions because it will require the Bank to start raising rates before it is obvious on the street that the economy is getting better." Gieve, who ended his three-year brief overseeing financial stability at the central bank on Friday, said policymakers needed to be wary of keeping rates too low for too long, which could fuel inflation when the recession finishes.
"When the recession does come to an end, will we overshoot the inflation target?" he said. "I don't think it would be the worst thing in the world if we overshot it a bit, but I don't want to turn this into a 1970s experience of really high inflation followed by savage measures to bring it under control."
The BoE has slashed interest rates to a record low of one percent from five percent since October and is expected to trim borrowing costs to 0.5 percent this week before embarking on a policy of quantitative easing, or boosting the money supply. British authorities hope those extraordinary measures, along with the government's extensive support package for banks and a 20 billion pound ($28.4 billion) fiscal stimulus, will breathe life back into Britain's fast-shrinking economy.
Gross domestic product shrank by 1.5 percent in the three months to December - the fastest pace of contraction since 1980 - and is expected to keep shrinking much of this year. "I hope we've reached the bottom," Gieve said. "This Asset Protection Scheme they have announced for RBS (Royal Bank of Scotland) and will announce for Lloyds (Banking Group) in the next few days is a convincing scheme."
"I hope it will provide a platform from which those two banks will be able to identify the living bits of the business and that, with what we're doing here and what they're doing with Citigroup and Bank of America in the US, we will see a gradual recovery," he said. The British government has launched a toxic asset insurance scheme whereby banks can protect themselves from losses arising from their most risky assets, in return for a fee.
Gieve faced heavy criticism from lawmakers and the media for not ringing alarm bells sooner over the risky behaviour of banks as the credit crunch took hold in 2007. "If I regret anything, it's not making more noise," he said. "If you look back at what we said, we did point out many of the vulnerabilities ... but we didn't bang the drum."