Bank of England policymakers should not wait much longer if they intend to adjust monetary policy toward more normal levels at a slow and gentle pace without squeezing household budgets too much in the future.
Last week's 'Super Thursday' at the Bank of England (BoE) showed that policymakers were more cautious than markets had been predicting. Expectations that global Brent Oil prices will continue to remain close to this year's lows, while domestically generated inflation pressures in the form of wage growth remain subdued, led the BoE to revise down its near-term outlook for CPI inflation by nearly one half, when based on market interest rate expectations.
For the BoE to be confident enough to start raising its base rate, wages in the UK will have to pick up faster than they have thus far since the 2008 financial crisis. Despite picking up pace recently, the longer-term post-crisis average remains well below the pre-crisis levels. While earnings increased on average by 4% before the economic slowdown between 2001 and 2008, the same measure of pay rose just 1.6% on average between January 2009 and May 2015.
According to the latest official figures, regular pay – that stripped of bonuses – picked up by 2.8% in the quarter to May, which was the highest level since January 2009. Wages in the private sector rose even faster, by 3.3%, offset by a significantly weak public sector where wages rose only 1.1% over the same period.
The wage picture looks pretty much unbalanced, but the current underlying growth appears promising, with BoE policymakers expecting it to increase even further toward the end of the year. This should be strong enough to offset strong downward pressures from cheaper oil and stronger sterling. At least that is what Ian McCafferty, the only dissenter at last Thursday's MPC rate announcement, thinks.
"Ian McCafferty preferred to increase Bank Rate by 25 basis points, given his view that demand growth and wage pressures were likely to be greater, and the margin of spare capacity smaller, than embodied in the Committee’s collective August projections," the August MPC Minutes said.
Before joining the BoE, McCafferty worked as Head of Macroeconomics at BP (LONDON:BP). This gives McCafferty obvious insight into oil price movements and their impact on CPI, which he used in his speech at Durham University Business School in March this year, when he argued that some effects of the significantly low price of oil "are potentially inflationary, in particular the boost to households’ real incomes, which stimulates the demand for, and prices of, non-energy goods and services."
Whether this leads to sharp increases in CPI in the medium-term remains highly uncertain, given the outlook for oil prices remaining notably on the downside. Iran is preparing to boost global supplies markedly, while none of the other oil-rich countries feel like cutting back production to allow for rebalancing the market, and price recovery.
For now, record-low inflation, in combination with rising wages, offers higher real income to households, who in turn feel less pressure on their budgets, after years of above-target inflation and low wages. But the risk that inflation overshoots the target again remains highly possible if the BoE continues to sit on rates for longer than necessary.
"Because this is not just about inflation, as you know, over the course of the next few months, but inflation for the medium term, so people don't have to worry about inflation, so people can enjoy the dividend, if you will, of lower petrol prices, lower food prices today, without worrying about a payback in the medium term," Governor Mark Carney said during the August Inflation Report press conference.
Considering that the policymakers refuse any adjustment in the base rate by other than 25 basis points increments, the first hike should come sooner rather than later, if domestic inflation picks up as expected. When asked by WBP Online about the notion of gradualism, Carney said the BoE had not had "any discussions of changing interest rates in anything other than the traditional increments of 25 basis points."
In that case, policymakers should not wait much longer if they intend to adjust monetary policy toward more normal levels at a slow and gentle pace without squeezing the budgets of the working people.
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