UK pay may be taking off but rates will stay grounded for a while yet

July 2, 2015

The Bank of England is seen through columns in LondonBritish wage growth will outstrip the Bank of England’s forecast this year but that doesn’t mean the first rate hike will come sooner.

For two years now, BoE Governor Mark Carney has drilled into the forecasting community and markets that a pickup in the pace of wage growth would be a prerequisite for hiking Bank Rate.

It is logical therefore to assume a recent surge in average earnings data signals the Bank has one less obstacle to contend with and probably will tighten policy soon.

But only three of 23 common contributors over the past few days and before the BoE’s June meeting brought forward predictions for the timing of the first Bank Rate hike since the summer of 2007. Most left their calls unchanged and some even said there is a risk the BoE could hike later than currently expected, which is for a rise in the first quarter of next year.

Combined Graph on BoE

The existential crisis in the euro zone over Greece is not yet over, and could still do damage to Britain’s top export destination, and by extension, to Britain.

And the Federal Reserve may put off its first interest rate hike in nearly a decade beyond September. Carney may be keen to lead from the front but it’s not likely that he wants to raise rates before Janet Yellen does. That could send the pound even higher and pull down inflation when it’s dangerously close to zero. That in turn could weigh down on inflation expectations, which still remain very low.

Wage-inflation-downgradesThe Bank has axed its wage growth prediction for this year three times, from 3.75 percent in its February 2014 inflation report to 2.5 percent in the latest one.

But it may have gone too far. Barring two months, British wage growth has been steadily rising for over a year and are doing so at rates last seen in August 2011.

April’s 2.7 percent rise blew past all expectations in a Reuters poll and is already above the BoE’s 2.5 percent prediction for the year.

Peter Dixon at Commerzbank said:

We have seen a decent surge in wage inflation of late and we are likely to breach the 3 percent barrier quite soon. Under these circumstances, it will take some very weak numbers to get us back to 2.5 percent by Q4.


Still, forecasters are reluctant to call for an earlier hike, as is the BoE’s chief economist Andy Haldane. That is probably because pay growth is unlikely to pick up to the lower-end of the pre-crisis 4-7 percent range until 2017, around the same time inflation is expected to hit the bank’s target of 2 percent.

“The exchange rate news may be more important quantitatively for the two-year-ahead inflation outlook than the recent news from wages,” Haldane said.

Economists at Goldman Sachs are also sounding dovish. They don’t expect a Fed rate hike until December and no BoE move until the second quarter of next year.

We expect those Committee members who tilt hawkish to do so on the back of the pick-up in wage growth (and unit labour costs, given weak labour productivity growth). Mr Weale acknowledged this view in the past month. We expect those Committee members who tilt more dovish than that to do so owing to the downside risk to wage growth that stems from a long period of low headline inflation. These Committee members may also want to confirm that the pick-up in wage growth is not simply coming at the expense of profit margins and is indeed pushing up on the inflation outlook.

 – with reporting by Swati Chaturvedi

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