MacroScope

Fed and BoE to markets: pay attention to pay

July 15, 2014

A bookie holds a wad of cash on the third day of the Cheltenham Festival horse racing meetingIt is more than a bit ironic that those paid the most to pay attention to incoming data aren’t paying enough attention to pay.

Both Bank of England Governor Mark Carney and Federal Reserve Chair Janet Yellen have dropped many hints in speeches and public policy statements over the past several months that wage inflation likely will play an important role in any decision to raise interest rates.

Carney also made clear in parliamentary testimony on Tuesday that his interest rate rise warning last month that took so many off guard was a deliberate attempt to inject some volatility back into a very sleepy and complacent interest rate futures market.

It was old school, and it worked.

Much like a central banker would do in the days before the financial crisis, now Carney says the data will dictate where rates will go.

And judging by the data, the first rate hike from record lows is still a long way off.

Short sterling interest rate futures traders were busy on Tuesday ramping up expectations for an early UK interest rate hike, perhaps for later this year.

That was based on a surprise rise in inflation, driven mainly by the fact an early British summer has emboldened many clothing retailers from delivering the same kinds of discounts they did last year, including footwear.

So they were flip-flopping over the price of flip-flops in June.

But data expected on Wednesday are likely to show very weak pay rises, despite an improving job market.

Indeed, average earnings growth is expected to slip to 0.5 percent in the three months to May on a year ago, from an already weak 0.7 percent.

UK pay pollThe story is similar in the U.S., where June retail sales disappointed despite solid rises in consumer credit.

Why? Pay is barely keeping up with inflation.

And let’s not forget the Fed’s money printer is still churning out tens of billions of dollars a month.

Back in April — long before we learned that the U.S. economy contracted by nearly 3 percent, annualized, at the start of the year — Yellen was clear on how important job market slack and wage inflation would be to any future decision to raise rates.

At present, wage gains continue to proceed at a historically slow pace in this recovery, with few signs of a broad-based acceleration. As the extent of slack we see today diminishes, however, the FOMC will need to monitor these and other labor market indicators closely to judge how much slack remains and, therefore, how accommodative monetary policy should be.

In testimony to Congress on Tuesday, Yellen sounded a similar refrain:

Labor force participation appears weaker than one would expect based on the aging of the population and the level of unemployment. These and other indications that significant slack remains in labor markets are corroborated by the continued slow pace of growth in most measures of hourly compensation.

In other words, pay attention to low pay.

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