Bank of England governor Mark Carney has signalled that Britain’s faltering wage growth is to have an increasingly important bearing on when interest rates will rise.
His remarks could dampen speculation about a rate hike by the end of this year, with the latest figures showing wage rises running at 0.3%, well below inflation at 1.9% – meaning that pay is falling in real terms.
In a speech at the Commonwealth Games in Glasgow, Mr Carney said policy makers would update thinking at next month’s quarterly Inflation Report on how to take into account the prospects for pay.
Wage growth is already one of a number of indicators used by the Bank’s Monetary Policy Committee (MPC) to assess the level of “slack” or wasteful spare capacity in the economy – which they want to see narrowed before hiking rates.
But Mr Carney’s remarks appeared to suggest that next month the issue of pay could be given an added emphasis within the context of this “forward guidance” framework on rates.
He said: “While some indicators such as wages suggest that there was more labour supply than we had previously thought, it is also true that spare capacity is being used up a bit more rapidly than we had expected.
“A key judgment for the MPC is when and to what extent these developments will translate into real wage growth, and in turn that wage growth into price pressures.
“Next month’s Inflation Report provides the next opportunity to update our thinking on these important questions.”
His remarks appeared to echo a passage in the newly-released minutes of the latest MPC meeting.
It pointed to the increasing uncertainty over the measure of “slack”, adding: “In light of this uncertainty, an argument could be made for putting more stress on the expected path of costs, particularly wages, in assessing inflationary pressures.”
John Bulford, economic adviser to the EY ITEM Club, said: “The MPC will ultimately make its decision with a heavy nod towards where wage growth is headed, rather than where it has been.
“With this in mind, it looks likely that the first rate hike will come in early 2015, a little later than markets currently anticipate.”
The governor’s remarks may revive claims that he is moving the goalposts on monetary policy, which have seen him labelled an “unreliable boyfriend”.
Mr Carney’s flagship “forward guidance” policy on rates initially focused on the rate of unemployment as a threshold for when rates could rise – until this fell much more quickly than expected.
This was soon replaced by the concept of “slack”, a wider, more opaque measure.
But this has proved hard to judge because of apparently conflicting signals from the labour market showing that while employment is improving strongly, wages are stagnant.
Earlier this year, at the launch of May’s Inflation Report, Mr Carney appeared to dampen expectations of a hike but a month later used the annual Mansion House speech to warn that a rise could come sooner than markets thought.
Mr Carney also used today’s speech to reiterate that when rates do start to rise it will be “gradual and limited”.
He said: “This is in part because the headwinds facing the economy are likely to take some time to die down.
“These headwinds include public balance sheet repair, a highly-indebted private sector likely to be particularly sensitive to interest rates, as well as the drag from a 12% appreciation of sterling over the past year and the persistent muted demand from our main export markets.”
Today’s MPC minutes indicated its nine members were divided over whether an early interest rate hike would derail the recovery – with “striking” weak wage growth leading some to urge caution.
They showed the committee voted unanimously to keep rates at 0.5% earlier this month but analysts said their discussion revealed the intensifying debate over the timing of a rise.
Some toyed with the idea that Britain might be ready for an early rate hike experiment and argued that the risk of this “derailing the expansion” had receded as Britain’s recovery had become more established.
But others put forward an alternative view that an unexpected hike in interest rates at a time when wage growth remained weak could destabilise the recovery.
The minutes also pointed to signs of housing activity cooling as well as indications of fading global growth.
Policymakers have held interest rates at the historic low of 0.5% for more than five years to nurse the economy back to health from recession.
But the accelerating recovery has brought forward expectations about when they will rise again, as the Bank tries to keep a lid on the future path of inflation while at the same time not stopping growth.
In a public question and answer session after his speech, Mr Carney said: “The answer to the question of when the first rate increase will happen will be determined by how the economy performs.
“The economy has a little more momentum than we previously thought, that’s welcome, and we’re using up spare capacity but there are some conflicting signals about how much spare capacity we started with.
“We see, for example, the softness of wages that has persisted.
“So what we are doing as individuals on the MPC is we are weighing those various factors and we will give an update on our thinking in the next inflation report which comes out on August 8 or so.
“The clearest indication of when interest rates are going to rise is when they rise.
“What’s most relevant from a business perspective, I would argue and certainly in all our discussions with businesses it’s been confirmed, is where is the medium term path for rates.
“And the fact is we are still living in extraordinary times. It’s welcome news that the UK economy is starting to move back to normal and with that would come an increase in interest rates.
“But none of us should forget the extraordinary forces that are still weighing on this economy in terms of weaker demand but also on the overall system.”
He said the adjusted interest rate will be “materially less than it was previously”.