How Will Higher Wages Affect Bank Of England Policy?

Includes: EWU, FXB
by: Discount Fountain


Wage growth is rising faster than expected in the United Kingdom.

While official inflation has fallen, lower prices have not necessarily translated into a lower cost of living.

The Bank of England is likely to prioritize growth before inflation in making a potential interest rate decision.

This past Wednesday, it was reported that wage growth in the United Kingdom may actually be rising faster than had previously been anticipated. According to the Wall Street Journal, when factoring for only full-time work in the private sector, wages are reportedly rising at a rate of 3.3 percent annually. While there have been concerns over deflation in the United Kingdom, higher wage growth is clearly an encouraging sign. Indeed, wage growth below expectations in the United States has led the Federal Reserve to take a more cautious stance on interest rates. In the case of the Bank of England, could higher wages lead to a more aggressive winding down of quantitative easing?

With interest rates being kept at 0.5 percent in June, concerns of lower prices clearly did not panic the central bank enough to warrant a rate cut. Indeed, a rate cut would only make sense from a growth perspective if it were for an extended period, as the ECB is currently doing. This is truly an unprecedented time for monetary policy as in spite of lowering prices, interest rates have been kept low for an extended period to encourage further spending. In the case of the United Kingdom, the effects of lower prices have not necessarily been universal. For instance, while oil prices have come down significantly, reductions in energy tariffs have not been fully passed through. In this regard, while official inflation has fallen, it does not necessarily mean that UK citizens universally enjoy a lower cost of living as a result.

As a result, I suspect that the Bank of England will look to growth first and foremost in deciding whether to raise interest rates. As I suspect is the case with many central banks across the world, the Bank of England will be unlikely to make any decisions before the Federal Reserve has raised rates; an overly strong pound could threaten exports and lead to a reversal of economic growth. When looking back over the past year, growth in Q1 2014 started out relatively strong at 0.9 percent, before dipping to 0.6 percent in Q4 2014 and finally 0.3 percent in the most recent quarter. I would suspect that the results of Q2 growth in the United Kingdom will be a significant indicator as to how the Bank of England will proceed. While wage growth is reportedly higher, this will have limited effects unless reflected in real growth. As a result, I suspect that the BOE would be looking for a significantly higher growth rate of 0.6 percent or above to warrant an interest rate rise.

To conclude, while wage growth is a positive indicator for rising inflation, the Bank of England will likely prioritize GDP growth first and foremost. In this context, wage growth may take longer than one quarter to reflect in GDP growth, and the Bank of England will likely continue to keep interest rates unchanged for the foreseeable future.

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