Bank of England inflation report: pay puzzle gives Carney some wriggle room

The message from the Bank of England was clear.

As clear as mud, that is. The economy is a mystery to the best brains of Threadneedle Street, scratching their heads at figures showing unemployment and earnings growth are both heading south at a rapid pace.

This really shouldn't be happening as far as the Bank is concerned, which is why its quarterly inflation report was riddled with uncertainty. The Bank's monetary policy committee is at odds about how much spare capacity remains after the Great Recession. Policymakers are unsure what is happening to the housing market. Some of them think wage growth is about to pick up; some of them don't.

Mark Carney, the Bank's governor, bridled at suggestions that the MPC doesn't really have a clue about what's going on and that therefore any guidance the Bank gave about the future path of interest rates should be taken with a bucket load of salt. Increases in bank rate, when they come, were likely to be "gradual and limited". Short of breaking into Stevie Wonder's Don't You Worry 'Bout a Thing, Carney could not have been more emollient or reassuring.

"Even if spare capacity were to be eliminated at a stroke overnight, the appropriate level of Bank Rate would not be far from where it is today", he said.

It is entirely possible that the governor is right about that. The history of the labour market for the past quarter of a century is that unemployment can fall for long periods without higher wage increase putting upward pressure on inflation.

That was the case in the 1980s, when it took a momumental housing boom to derail the economy. It was even more the case in the decade and a half between Britain leaving the Exchange Rate Mechanism on Black Wednesday in 1992 and the start of the financial crisis in 2007. The notion that something structural has happened in the labour market is supported by the moderation of earnings growth in the years running up to the financial crisis and the extraordinarily weak wage growth subsequently.

According to the Office for National Statistics, there are more than 800,000 people employed than there were a year ago but the rate of average earnings growth - once bonuses have been stripped out - halved from 1.2% to 0.6%. The Bank has halved its forecast for earnings growth by the end of 2014 from 2.5% to 1.25%.

The City viewed the ONS data and the inflation report as dovish. With real incomes being caned, the likely date for the first increase in bank rate has been pushed back from the end of 2014 to early 2015. Sterling fell as markets took heed of Carney's comment that even when borrowing costs do rise they will settle at a lower level than before the recession.

This was an "expectation not a promise", the governor said, leaving himself some wriggle room. And no wonder. This, after all, is the Bank that forecast a year ago that it would take until 2016 for unemployment to dip below 7%, something that happened within six months. It is the Bank that expresses surprise, regular as clockwork, every three months about the divergent trends in the labour market.

Whatever Carney says, the Bank is groping around in the dark. At the moment it doesn't really know what's going on but hopes that if it sits tight for long enough, the fog covering the economy will lift.

Powered by article was written by Larry Elliott, economics editor, for on Wednesday 13th August 2014 13.50 Europe/London © Guardian News and Media Limited 2010


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