Shadow MPC: If base doesn’t rise in 2014, then when?

Interest rate rises threatened by Carney six months ago have failed to materialise and the Bank of England is keeping markets guessing, as experts ask, ‘If not 2014, when?

Dev Malle no background

There is no doubt that Mark Carney has bought a personality to the role of governor of the Bank of England, but few would have expected that this would include a dose of humour. Putting the market on guard with the forecast of an interest rate increase six months ago was brushed away at the last Monetary Policy Committee meeting despite pressure from Martin Weale and Ian McCafferty, who for the second time voted for a 25 basis points increase in the rate.

Yes, much of their decision was based on pre-emptive action as we saw unemployment falling again and signs that wages have started to creep. However, it appears the underlying concern these members have is around rate shock and wanting the market and households to adjust gradually as interest rates are increased to a new norm.

So how is wage inflation looking? Well, there is no doubt that wages have lagged behind inflation which has put strain on household balance sheets. I will talk about inflation later but there are early signs that wages are picking up with the latest jobs data showing increases of 0.6 per cent in June and 0.7 per cent in July.

Annually when we take into account bonuses (which were lower than expected in April) the figure sits at 0.3 per cent. Whilst we have seen these modest increases recently, it is clear that overall wage increases remain weak and raises a real concern over what a meaningful interest rate increase could be especially where there are fragile household balance sheets.

On inflation, let’s remind ourselves that the Bank’s mandate is to control inflation at 2 per cent. In reality we have been seeing a slide from June at 1.9 per cent, July at 1.6 per cent and August at 1.5 per cent. In fact, inflation has now been below the 2 per cent target for eight months. Notwithstanding the inflation slide, the cost of living remains well above wage increases and this net negative position does not bode well for sustainable growth.

Following the introduction of forward guidance mark II in February this year, the concept of “slack” in the economy was highlighted, the view being that spare capacity in the economy existed which would allow growth at a faster rate without the need to apply constraint through interest rate increases.

Since then, there seems to be confusion as to the amount of slack that actually exists, except that, there was more than originally thought and despite some of it being used up as we accelerated growth, there is more to be used. This is one of the reasons why wage inflation is considered to be a key indicator on the basis (without stating the obvious) that wages will increase at a faster rate as the spare capacity gets used up. In Carney’s own words “In light of the heightened uncertainty about the current degree of slack, the Committee will be placing particular importance on the prospective paths for wages and unit labour costs”.

Whilst the Bank will look at these economic indicators, they will also need to take note of what is happening on the ground as early indicators for heating or cooling. Whilst anecdotal, there is clear concern that there is a cooling in the housing market, with Estate Agents reporting a drop off on new instructions in August of between 5 and 10 per cent.

Further evidence is the start of price wars between lenders to hit market share and volume requirements as we approach year-end. Whilst it is anticipated much of this will be driven through an increase remortgage activity supported by fixed rates, it is also accepted that this is not as easy as it was in the past, as MMR requirements need to be met. Again, if we needed evidence, we have seen the start of 10-day sales by some lenders.

So where does this leave us on rates? If I take into account that there was more slack in the economy than initially thought, which can be evidenced by only modest wage inflation and put this against the sliding inflation levels which now sit 0.5 per cent below the Bank’s target, I believe it pretty much rules out a 2014 rate increase.

So if not 2014, when? We need to understand the extent to which the economy has cooled and whether the anecdotal can be evidenced in inflation, wage levels and the housing market. However, at the risk of being accused of being a cynic over the Bank’s independence, with an election looming in May, I believe we may be waiting until Q2 2015 before we see even a modest increase in rates.