The UK Inflation rate is expected to slow down in July after it spiked sharply toward the target a month earlier. Price pressures remain subdued as the Bank of England struggles with the wage growth conundrum.
Consumer price inflation is expected to float below the official target of 2% until the third quarter of 2017, according to Bank of England's (BoE) August Inflation Report medium-term forecasts.
The rate of Consumer Price Index (CPI) inflation in Britain remains subdued partly due to sterling's substantial gains against its major peers, especially the US dollar, in the last twelve months. The central bank's policymakers view sterling's appreciation as one possible downward pressure on import prices, and consequently, on CPI inflation.
In July, inflation rate is expected to slow to 1.8%, down from a sudden spike to 1.9% in June, which the official statisticians attributed to the UK retailers postponing their summer sales due to unusually warm and dry weather. The core CPI, which excludes volatile data on energy, food, tobacco and alcohol, should also ease to a rise of 1.9%, down from 2%. The Office for National Statistics (ONS) is releasing the July data on Tuesday morning.
Inflation in Britain remains subdued despite the pace of economic growth which has been strongest among the seven most advanced economies. Apart from a downward push from stronger sterling, price pressures remain subdued due to tentative signs of a global slow down, especially in the eurozone, where growth slowed to a halt in the second quarter while the common currency union struggles with significant deflationary pressures.
Weak wage growth conundrum
Weak wage growth and more slack in the UK labor market are also partly behind subdued inflation, which allows BoE to keep monetary policy ultra loose for longer without the risk of stoking price pressures upward.
In its August Inflation Report (IR), BoE sharply slashed the 2014 annual wage growth estimate by a half, from 2.5% down to 1.25%. The UK wage growth has also become a significant figure to watch for after the top BoE policymakers, including Governor Carney, made numerous explicit references to earnings being the primary variable to measure labor cost inflation in the medium term.
To add to the conundrum, Carney's comments in the Sunday Times interview last week suggested the central bank would not wait for the wages to pick up in order to begin tightening the policy: "We have to have the confidence that real wages are going to be growing sustainably [before rates go up]. We don’t have to wait for the fact of that turn to do so," Carney said in the interview.
Weak wage growth and its subdued push on inflation, which appears to have been the only weapon in the hands of the doves at the moment, may be only temporary, or may last for much longer than policymakers now expect. Therefore, if wages rise in the upcoming months, then the case for an earlier rate hike may strengthen. If, on the other hand, wages remain weak for longer than expected, then the case for keeping the bank rate at a record low even further beyond early next year could undermine BoE credibility.
Subdued wages versus weak productivity
Rising wages while productivity remains weak could also increase upward inflationary pressures.
In the BoE's new central view presented within the August IR, productivity growth is to pick up more slowly in the near term, while it is expected to remain below its pre-crisis average rate throughout the forecast period.
Given that productivity growth remains weak, Berenberg bank UK chief economist Robert Wood argued last week that in such a case "the economy cannot sustain normal wage growth like the 4-5% average seen before the crisis without setting off inflation”.
Also, stronger growth in the second quarter, a briskly falling jobless rate, and a faster tightening of slack in the labor market could soon translate into a rate hike vote among some less dovish MPC members.
It is also clear that there is a group of less dovish policymakers at the MPC who saw "the risk of a small rise in rate derailing the expansion and leaving inflation below the target in the medium term was receding as that expansion became more established."
More detailed information on the sentiment and a vote pattern will be revealed on Wednesday this week within the minutes from the August MPC meeting. Some economy watchers expect at least one member voted for a rate hike in August.
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