Bank of England slashes wages forecast, says key for policy

[August 13, 2014] By David Milliken and Paul Sandle

LONDON (Reuters) - The Bank of England forecast on Wednesday that wages would grow far more slowly than previously expected and linked their rate of increase closely to borrowing costs, suggesting it was in no hurry to raise Britain's record low interest rates.

Shortly after data showed average British wages suffered their first fall in more than five years in the second quarter of 2014, the Bank cut its forecast for wage growth this year in half to 1.25 percent.

Sterling fell sharply to a 10-week low against the U.S. dollar and British government bond prices pared losses after the announcement by the Bank, which caused markets to reduce bets on the possibility of a first rate hike before the end of 2014.

The central bank also forecast a bigger fall in unemployment than it had in its last set of forecasts in May - and suggested the jobless rate could fall further than previously expected before wage pressures increased as it edged up its prediction for already strong economic growth.

Bank Governor Mark Carney said the speed of the fall in Britain's unemployment rate meant there was now less room for growth without inflation than the BoE had forecast earlier this year. But there were also signs that there had been more spare capacity in the first place than the Bank originally forecast.
 

"Whatever the causes, these developments point to the economy being able to sustain a higher level of employment and lower rate of unemployment without generating additional inflationary pressures," Carney told a news conference.

The Bank indicated that wage developments would be key to the exact timing of a rate move.

"In light of the heightened uncertainty about the current degree of slack, the Committee noted the importance of monitoring the expected path of costs, particularly wages," the BoE said in its quarterly Inflation Report.

The BoE's forecasts are based on market assumptions that it will raise rates in February next year, three months earlier than when the Bank published its last forecasts in May.

That timeframe would probably make Britain the first major economy to raise interest rates since the end of financial crisis.

The central bank stuck with its pre-existing guidance that future rate rises would be gradual and to a level well below pre-crisis norms.

LESS SLACK

The BoE said its policymakers now believed that there was spare capacity of roughly 1 percent of gross domestic product in the economy. This was down from around 1.25 percent it estimated in February and May, a figure which Carney on Wednesday suggested may have been too low.

The BoE has said that it wants slack to be largely used up before it raises interest rates.

The increased uncertainty about slack meant that there was a wide range of views on the rate-setting Monetary Policy Committee about how much was left, the BoE said.

Most economists polled by Reuters expected at least one MPC member to have voted for a rate rise earlier this month. Members' voting records will be published next week.

Britain's economy looks set to grow faster than any other big industrialized nation this year, and house prices have jumped by 10 percent over the past 12 months, raising fears of a new property bubble.

But the economy has only just recovered to the size it was before the financial crisis, having taken far longer than most of its peers to get growth going again, and wage growth is strikingly weak.

Figures released earlier on Wednesday showed that wages fell by 0.2 percent in the second quarter of this year compared to the same point in 2013 - a bigger drop than BoE had pencilled into its forecasts, which were made before the data.
 

But unemployment fell to 6.4 percent, and the BoE expects it to drop even more than it forecast before, sinking to 5.4 percent in two years' time, lower than the 5.9 percent it predicted in May.

However, this fall in unemployment does not necessarily point to inflation pressures. The BoE sharply lowered its estimate of the so-called equilibrium unemployment rate - the rate at which the number of people out of work stops weighing on wages - to 5.5 percent from 6.25 percent.

The BoE slightly revised up its growth forecast for this year to 3.5 percent from 3.4 percent - which would be one of Britain's fastest growth rates in more than a decade - and said it expected inflation - currently 1.9 percent - to be around 1.8 percent in two years' time.

Economists polled by Reuters on average expect the BoE to raise rates in the first quarter of 2015, while financial markets see a roughly one in three chance of a move by November.

(Writing by David Milliken and William Schomberg, editing by John Stonestreet)

[© 2014 Thomson Reuters. All rights reserved.]

Copyright 2014 Reuters. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.