Shafik: I will proceed with caution.
Wage pressures aren’t yet strong enough to justify an interest-rate increase, though markets have misjudged the delay until the first move, according to Bank of England deputy governor for Markets and Banking Minouche Shafik.
“I will wait until I am convinced that wage growth will be sustained at a level consistent with inflation returning to target before voting for an increase. In that sense, I will proceed with caution,” Shafik said in a speech in London yesterday.
“But once I am convinced, absent further shocks, I can see bank rate rising more quickly than the path implied by the market curve at the time of the last Inflation Report,” she added.
The Monetary Policy Committee has put the labour market at the centre of policy as it considers the first rate increase in more than eight years. Shafik — who has consistently voted with the majority of the nine-member panel to keep the key rate at a record-low 0.5% — said that while the UK economy is returning to normal, officials “cannot blithely assume” it will behave in the same way as before the financial crisis.
As the unemployment rate declines, officials have signalled the next move in rates will be up. While economists predict the first full quarter-point increase will come in the second or third quarter of next year, investors are betting it won’t happen until 2017.
Market pricing for the first increase in March 2017 and a rate of 1.25% by the end of 2018 may reflect the fact that investors are accounting for the prospect of downside risks materializing, Shafik said.
“This would be consistent with the risks to the world economy that have come to the fore over the past year as emerging economies grapple with the twin challenges of transitioning to slower potential output growth and lower commodity prices,” she said. “Although the direct trade links between emerging economies and the UK are relatively small, the indirect effects of a more dramatic emerging-market slowdown through confidence and financial channels could be significant.”
In their December policy statement, officials weighed “robust growth” in spending against weak overseas demand and said feeble inflation gives them room to maintain emergency settings for now. Falling oil prices, subdued wages and an appreciation of the pound have damped the outlook, they said. The strength of the currency is putting “significant downward pressure on inflation,” Shafik said, and will probably continue to do so “for several years to come as lower import costs pass through the supply chain.”
The pound has gained almost 10% against the euro, the currency of Britain’s biggest trading partner, in the past 12 months.
Inflation held below zero for a second month in October, and November’s data today is forecast to show little improvement. A report due tomorrow will probably show that basic earnings growth cooled to 2.3% in the three months through October from 2.5% a month earlier. That would mark the weakest reading since the first quarter. The Office for National Statistics data may also show the unemployment rate held at 5.3%, matching September’s reading which was the lowest in more than seven years. Shafik said the rate of pay growth “seems to have levelled off again in the most recent data,” though the pause may yet “prove to be more noise than signal.”
“There are many signs that the economy is normalising,” Shafik said. “We still learning how the post-crisis economy behaves, and some relationships in the data have proven slow to reassert themselves or may have changed.”
Officials need to retain flexibility when setting policy, she said.
“When the time does come to raise bank rate, it will be important to retain the flexibility to change course if needs be, either by tightening policy more quickly than originally envisaged or by being prepared to loosen again,” Shafik said. The BoE could use bank rate or quantitative easing “were it required to respond to unforeseen events,” she said.
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