Increasing the base cost of lending could prove to be the only effective method of cooling runaway house price inflation, deputy governor of the Bank of England Charlie Bean has warned.
Bean delivered the warning in a speech to the London School of Economics, ahead of his departure from the bank after 14 years next month.
‘Monetary policy may be a blunt tool for addressing financial stability risks, but it does have the virtue that it gets in all of the cracks,’ he said. ‘So, there may well be times when monetary policy is the only game in town to guard against incipient financial stability risks.’
He added that it was inevitable that the economy would encounter come ‘potholes’ on the way to policy normalisation, however.
‘Implied volatilities in many financial markets have been at historically low levels for some time now. Together with low safe interest rates in the advanced economies, that has underpinned a renewed search for yield and encouraged carry trades.
‘Taken in isolation, this is eerily reminiscent of what happened in the run-up to the crisis. Episodes like the ‘taper tantrum’, which produced a short-lived bout of volatility but no major disruption may also be contributing to a sense of complacency and an underestimation of market risk by investors.
‘It is inevitable that at some stage market perceptions of uncertainty will revert to more normal levels… The bottom line is that we may yet encounter a few potholes on the way to the exit.’
He added that the banking system was now much better capitalised than during the last credit cycle and leverage lower across the economy.
‘Those emerging economies that have financed large external deficits through the accumulation of foreign currency debt may be more vulnerable, however.’