MNI INTERVIEW: BOE Likely To Revise Up View Of Wage Growth

The Bank of England will come under pressure to revise its prediction for wages growth to ease rapidly as it adjusts higher its view of the level of unemployment compatible with its inflation target, National Institute of Economic and Social Research Deputy Director Stephen Millard told MNI.

In its August Monetary Policy Report, the BOE foresaw earnings growth dropping from 6% in 2023 to 3.5% in 2024 and 2.5% in 2025, but Monetary Policy Committee minutes noted that pay has risen more strongly than the Bank's standard models would have predicted. This in turn suggests that U*, the estimated unemployment rate at which inflation is stable, is higher than the Bank has assumed and will be revised up, Millard said in an interview.

"I think they're trying to ... prepare people for that by saying, 'Well ..we have these models. And they're all under-predicting wage growth. So we need to rethink what's driving wage growth,” he said. “That .. gives them a bit of wriggle room to come back in a quarter or two and say, well, we' ve rethought about wage growth and we've decided that it was higher than the models were saying because we were using a value of U* that was too low.” (See MNI INTERVIEW:UK With Higher NAIRU More Prone To Wage Pressure)

The BOE currently expects unemployment to drift up from around 4% to around 5%, which on its current estimate of U* at around 4.25% would be disinflationary. But it is likely to shift towards NIESR’s view of the equilibrium rate of unemployment as being around 5%. (See MNI POLICY: BOE Looks At Raising Equilibrium Jobless Estimate)

NIESR agrees with the BOE’s view of the likely path of actual unemployment, but foresees average weekly earnings growth holding at around 6% this year and next.

LABOUR MARKET STOCK TAKE

Bank economists would typically complete a labour market stock-take around year end for publication in the February Monetary Policy Report but comments by Governor Andrew Bailey at the August press conference suggested some of the work could be released in November. MPC members will already be taking higher pay pressures into account, Millard said.

"MPC members themselves, if they see plenty of evidence that U* is higher than they had thought previously, will adjust their policy to take that new belief into consideration,” he said. “We can put a lot of emphasis on the supply stock-take but actually the MPC members themselves will be doing those kinds of calculations in their heads as they go, as they see data come out.”

While the difference between current and equilibrium unemployment, or U minus U*, is only a narrow assessment of labour market slack, taking no account of changes in levels of workforce participation, it will still influence the MPC, according to Millard.

"While different members of the MPC will have different views as to the amount of additional slack that is out there, I think they'd probably all hold to the view that if you have a good measure of slack that does tell you something about future inflation," he said.

The latest evidence from other labour market measures suggests that while the labour market is easing it remains tight by historic standards. Millard's preferred measure, the ratio of vacancies to unemployment, has dropped to 0.77, compared to its long-run average of 0.42 although well below its previously unprecedented peak of 1.03 in the first quarter of 2022.