Pay rises to lag behind inflation

Thursday 14 August 2014

The Bank of England has ditched its forecast for real-terms wage growth to return this year as it signalled that it was placing increasing emphasis on weak pay data in deciding when to raise interest rates.

Policy-makers halved their prediction for wage growth this year from 2.5% to 1.25%, meaning it will continue to lag behind inflation, figures in the Bank's quarterly inflation report showed today.

Official quarterly pay data published shortly ahead of the report were even worse than the Bank had thought, and therefore likely to dampen speculation about an interest rate hike this year.

The Bank's predictions for the wider economy were better, with UK growth figures upgraded from 3.4% to 3.5% for this year, and from 2.9% to 3% for next year.

Unemployment is expected to drop more quickly, falling below a rate of 6% this year, while inflation projections were little changed, hovering just below 2% over the next three years.

The Bank said the key measure of wasteful spare capacity or slack in the economy had narrowed slightly to around 1%, compared to a previous level of around 1.25%.

Slack is the measure that the monetary policy committee (MPC) has said it wants to see narrowed before there can be any rates hike, but there have been contradictory signals about this as real wages fall and jobs grow strongly.

Bank governor Mark Carney said: "In light of the heightened uncertainty about the current degree of slack, the committee will be placing particular importance on the prospective paths for wages and unit labour costs."

Mr Carney maintained that forward guidance on interest rate policy remained unchanged and there would not be a "magic number" for wage growth that would prompt a hike. But the shift in emphasis is likely to prompt renewed suggestions that the governor's changing stance on rates is like the behaviour of an "unreliable boyfriend".

It comes a year after Mr Carney introduced the first version of forward guidance, linking any rate hike to unemployment falling to 7% - which had to be ditched after six months when job numbers improved much more quickly than expected.

The governor said that despite the new emphasis on pay, the MPC "does not have a particular threshold for wage growth" to decide when it considers an increase. He reiterated that rate rises when they do come would be "gradual and limited" but added that this was "an expectation, not a promise".

Members of the MPC have been divided over whether an early hike would hamper the recovery by pushing up borrowing costs. Markets are expecting rates to start rising in February but some experts have been pencilling in a rise as early as November.

The Bank acknowledged that the weakness in wages meant its key measure of slack had been greater in the past than had previously been thought, though it was now being used up more quickly than had been expected. There has been contradictory evidence about the level of spare capacity in the economy, with job numbers improving strongly - and Mr Carney today cited an increase of 800,000 jobs in the past year.

The pound fell a cent against both the dollar and the euro on dampened expectations of an interest rate hike.

Shadow chief secretary to the Treasury Chris Leslie said: "This report shows why this is no time for complacent and out-of-touch claims from ministers that the economy is fixed and people are better off. While the economy is finally growing again and unemployment is falling, working people are still seeing their living standards squeezed. Pay growth is at a record low and lagging behind inflation and the Bank of England has halved its forecasts for wage growth this year."