LONDON (Thomson Financial) - Paul Tucker, a rate-setter at the Bank of England, hinted that interest rates in the UK are nearing levels at which they will really bite into economic activity.

In a speech at a Merrill Lynch conference, Tucker said monetary conditions — a base rate of 5.25 pct and a modestly sloping money market curve — are “edging towards being restrictive” so long as inflation falls back as expected in the near term.

“That has been appropriate given the degree of pricing power apparently emergent in conditions of high capacity utilisation among firms,” he said.

“It has provide the platform needed going forward to restrain inflation pressures, and to maintain anchored inflation expectations, at a time when, understandably there is public debate about the outlook given that CPI inflation rose above 3 pct for the first time, triggering an open letter from the Governor (Mervyn King) to the Chancellor (Gordon Brown),” he added.

Looking ahead, he said his votes on the Monetary Policy Committee will “depend on balancing the medium-term prospect for demand pressures alongside uncertainties about supply conditions and near-term inflation expectations caused by volatility in energy costs”.

He added that this will entail making judgements about a whole range of influences, including whether or not residual slack in the labour market might in time, given robust business investment, help to ease capacity constraints.

He also said it will depend on whether competitive conditions among retailers will dampen the feed through of accelerating producer prices into consumer prices and whether wage bargainers and price setters recognise the “absolute determination” of the MPC to maintain price stability.

Tucker, widely considered an arch hawk at the time of the January rate hike, also explained why he voted to keep rates on hold at the start of the year.

“CPI inflation had risen quite sharply, but was, and I should say, still is, also expected to fall back quite sharply towards the 2 pct target,” he said.

“Provided that broadly ‘humped’ path for inflation materialised over the coming months, the upside risk to medium-term inflation expectations seemed likely to subside,” he added.

He denied that his vote against the hike was a a matter of his wanting to avoid surprising the markets, which in the “greater scheme of things is neither here nor there”.

Rather, Tucker said he was concerned that an immediate move might cause “unnecessary confusion” among the committee’s view of the medium-term outlook for inflation and about monetary strategy.

“In the event, subsequent speeches by colleagues and the medium-term perspective of the February Inflation Report, helped to keep that genie in the bottle,” he said.

Tucker also revealed that he was “strongly” in favour of widening the width of the Inflation Report’s fan chart for inflation in the coming year in February “to underline the near-term uncertainty about, and the great difficulty in forecasting, the path of utility prices”.

It was “vital”, he said, to convey the medium-term prospect and “also that we stand ready to act if the risks warranted it”.

pan.pylas@thomson.com

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