MPC eyes wage inflation as rates stay lower for longer
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We’ve argued that the Bank of England’s Monetary Policy Committee (MPC) will likely look through the impact of lower oil prices on the rate of inflation but in determining how to set the Official Rate will be gimlet eyed on wage inflation – and so yesterday’s news is important in informing our thinking with both Minutes of the last MPC meeting and also data on the UK labour markets.
Looking first at the minutes of its latest meeting, the MPC acknowledged that the early signs of a pick-up in pay growth tentatively suggested that slack was lower, or being absorbed more quickly, than previously thought. It also judged that both the lower oil price and the fall in market interest rates would stimulate growth.
Against that, though, the weaker near-term inflation outlook has raised concerns for the MPC that the drop in inflation might become more persistent by lowering inflation expectations and pay growth. It is reported that the Committee now thinks that there is a roughly even chance of some deflation during the first half of this year and noted that this could arrive at the time of year when a large proportion of pay claims are settled, possibly boosting the chances of a self-perpetuating deflationary spiral.
On the jobs front, the latest labour market figures have revealed that the recovery in real wages is now gathering pace with annual pay growth outpacing inflation for the third month in a row in November, while the headline (three month average of the annual) rate picked up from 1.4% to 1.7%.
Looking forward, recovery in real wages should keep gathering pace given that inflation is still falling and nominal earnings growth is likely to accelerate further as the labour market tightens. We do not therefore subscribe to the view that a couple of months of CPI deflation will lead to reductions in wages. Bears will argue that employment only rose by a modest 32,000 in the three months to November, but given that the workforce contracted a bit, this was still enough to push the ILO unemployment rate down from 6% to 5.8%, and claimant count unemployment fell by almost 30,000 in December alone.
As to what this likely means for rates and markets, on balance an interest rate hike still looks some way off, and quite possibly not until next year as widely expected by markets at present, with the MPC’s current focus of attention on the risks of a persistent period of low inflation. It is however still possible that that we see an interest rate rise later this year as inflation starts to pick up again – although we should expect that in the context of the MPC remaining cautious, any rate rises will be very gradual.
James Bevan is chief investment officer of CCLA, specialist fund manager for charities and the public sector. CCLA launched The Public Sector Deposit Fund in 2011 to meet the needs of local authorities and other public sector organisations. You can follow James on twitter @jamesbevan_ccla
