MNI INTERVIEW: Supercore Shows Benign UK Disinflation Feasible

MNI (LONDON) - Recent trends in supercore wages and a measure of supercore services inflation suggest that the UK economy could be on the path to healthy disinflation, though uncertainty remains high, former New York Fed head of international studies Gianluca Benigno told MNI.

High wages growth is most likely driven by the recovery of purchasing power lost during recent inflation, rather than that increases in pay are driving a fresh inflationary impulse, said Benigno, adding that services inflation adjusts only slowly to shocks.

“My guess is that wages have caught up with inflation, rather than inflation being driven by wages,” he said in an interview, which comes as disagreements over the causes of persistent services price inflation are set to be central to debate within the Bank of England over whether to cut rates at its next meeting in August. (See MNI POLICY: BOE Split Over Measures Of Inflation Persistence)

 “There are idiosyncratic aspects related to the [post Covid] re-opening, to sectoral allocation, that might have driven wages in a way that is specific to a sector, and might not necessarily be … associated with prices increases,” he said, adding that as price shocks from Covid and the Ukraine invasion fade, so too could services inflation.

BOE Monetary Policy Committee member Swati Dhingra has expressed a similar view, highlighting energy and other non-labour input costs as driving inflation, while her more hawkish colleague Jonathan Haskel has focused on impaired labour supply. The debate on the MPC next month is likely to be tight, though there are signs that Chief Economist Huw Pill is tending towards the cautious option of holding rates. (See MNI POLICY: Path Narrows To August BOE Rate Cut)

In analysis for the May Monetary Policy Report using similar supercore measures to those constructed by Benigno, BOE economists found correlations between service and wage inflation were very sensitive to the sample time periods, making it hard to attribute persistently high services inflation to wages growth. They also cited a non-linear relationship between non-labour input costs and firms’ pricing decisions as they anticipate demand.

WAGES CONVERGE WITH SUPERCORE

“Goods prices tend to adjust faster … For services, the frequency of adjustment is slow, and as the shock tends to last longer, in some ways, the persistence of service inflation is also by-product of this slow adjustment of prices," Benigno said.

“The pass through of different shocks into prices depends very much, in my opinion, on the size of the shock. So the non-linearity is super important, and that is something that … has to be acknowledged in drawing some sort of interpretation of what we see.”

Recently growth in wages and supercore wage inflation have converged, reaching around 6% compared to 4% pre-Covid, and Benigno said he expected them to continue to move in line with each other.

"Ideally, they should converge at a lower level. If they converge at the lower level, I think that we are in a benign disinflation process in which I don't think the Bank of England should worry too much. It's just ... the adjustment to past shocks and so on," he said.

However, Benigno acknowledged that upside risks persist.

"I expect them to stay aligned. And if they stay up at 6% then I would be worried," he said.

Services "disinflation is present ... it’s just slow because of slow price frequency adjustment. ... looking ahead, I would be monitoring carefully to the extent to which wages are consistent with inflation development," Benigno said.

The BOE economists will revisit the question for the August MPR forecast round