Why the Bank of England will keep interest rates on hold despite lower inflation
The latest clutch of data is unlikely to change the Bank of England’s thinking ahead of its decision on interest rates next week.
The UK economy returned to growth in January, expanding 0.2 per cent thanks to a big boost in retail sales. This was in line with economists’ expectations.
This followed yesterday’s update on wages, which showed growth fell slightly faster than expected, although remaining at elevated levels, with total pay coming in at 5.6 per cent.
What does it mean for the Bank? As ever, it depends on who you ask.
Business groups are calling for policymakers to start lowering interest rates sooner rather than later.
“Despite a positive start to the year, the UK economy remains in a relatively fragile position. The case for an early cut in interest rates by the Bank of England is still a strong one,” Roger Barker, director of policy at the Institute of Directors, said.
A number of commentators have warned that the Bank risks waiting too long before cutting interest rates, potentially hamstringing the UK economy, having waited too long before hiking them in the first place.
But the Bank does not look like cutting rates any time soon.
Earlier this month, Huw Pill, the Bank’s chief economist, warned that rate cuts were still “some way off,” reflecting the approach taken by central banks around the world.
Indeed, the latest GDP and labour market figures demonstrate the tight spot the Bank finds itself in.
Inflation has come down faster than expected, while wage growth remains relatively high. This means households are getting a boost in real income. Yesterday’s figures showed real pay rose 1.4 per cent in the three months to January, the seventh consecutive month real pay has increased.
In other words, the further inflation falls while wage growth remains elevated, the more money households have to spend. This adds more demand to the economy, potentially stoking inflationary pressures.
Analysts at Pantheon Macroeconomics forecast that real disposable income will climb 2.2 per cent in 2024, helping consumer spending rebound two per cent in the year.
Now wage growth is on its way down, but it is very uncertain how fast it will fall in 2024. A Bank of England survey showed wage growth could stick at around five per cent over the coming year.
Why? For a start there’s a 10 per cent increase to the minimum wage coming down the track in April.
This will lift wages for those on a minimum wage, but it may also force up wages for those on higher salaries.
Secondly, unemployment remains very low, giving workers greater bargaining power. Speaking at an event in Italy yesterday, Andrew Bailey, governor of the Bank, said the UK was essentially at full employment.
“The pattern of disinflation with full employment is unusual in our modern history,” he said.
Bailey’s comment demonstrates the Bank’s uncertainty. The historical record suggests unemployment needs to go higher before inflation is brought sustainably to the target. So far, that has not happened.