Bank's chief economist Dale warns of inflation risk of QE

The chief economist at the Bank of England, Spencer Dale, has warned against low interest rates becoming a “long term crutch” for the country.

He also stressed that further asset purchases as part of the quantitative easing (QE) programme must only be made if there is no risk of causing inflation to rise.

"Monetary policy can and should provide short-term support in times of need, but it must avoid becoming a long-term crutch obstructing the required rebalancing of our economy," he said.

In a speech at a conference in Dublin, Mr Dale said that pumping more money into the economy would not work if the economies underlying weakness was because the economy did not have the spare capacity for growth.

Mr Dale said: "If the handbrake on your car is stuck, putting your foot further and further down on the accelerator won't get you very far before the car starts to overheat."

Mr Dale was one of only two dissenting voices when the Monetary Policy Committee (MPC) voted to add a further £50 billion to the current programme of asset purchases in July.

He said then that he was worried that more QE would fan the flames of higher inflation and that the inflation outlook was not sufficiently healthy to risk pumping more money into the economy.

Mr Dale has consistently warned that one of the effects of QE could be to cause higher inflation if the lack of economic growth was due to a lack of productive potential rather than a lack of demand.

Earlier this week, the bank decided to make no changes to policy, keeping interest rates at 0.50 per cent and its QE programme at £375 billion following encouraging data from the manufacturing, construction and services PMI readings for August.

Analysts expect the MPC to add a further £50 billion to the QE programme in November, taking the total up to £425 billion.

Inflation has fallen by half from its September 2011, 5.2 per cent peak, but went up to 2.6 per cent in July. The bank is hoping that it will fall towards its two per cent target by the end of the year.

Mr Dale believes the central bank needs to consider carefully the potential negative effects of more QE. He is concerned that a prolonged period of loose monetary policy could encourage investors to take risks that could delay necessary economic restructuring.

Mr Dale said: "If output growth remains weak, we will need to assess carefully developments in potential supply as well as demand before deciding how to respond.

"The rates of growth enjoyed prior to the crisis may not be the correct benchmark for the next few years.

"Above all, we need to remain firmly focused on hitting our inflation target."

Mr Dale said that there could be scope for more QE if the conditions were right.

He said: “If the economic outlook deteriorates further, policy can respond. We have not yet run out of road. But there are limits to how much we should ask of monetary policy."

In his speech Mr Dale also expressed confidence in the Bank of England’s Funding for Lending Scheme (FLS) to encourage banks to take advantage of lower borrowing rates and pass these on in the form of cheaper borrowing to businesses and individuals.

"The FLS takes off the table the constraint posed by high bank funding costs ... and in my view stands a good chance of making a material difference," Mr Dale said.