BOE Says Slack Has Fallen as Carney Puts Focus on Weak Wages
Bloomberg News
The Bank of England said the amount of spare capacity in the economy has fallen as it lowered its forecast for wage growth and said it will put more weight on earnings in its policy assessment.
In their Inflation Report published in London today, policy makers led by Governor Mark Carney said the amount of slack in the economy is in the region of 1 percent of gross domestic product. That compares with a previous estimate that put the mid-point at 1.25 percent. While the BOE said slack is being absorbed faster than previously anticipated, it said the pace of erosion will slow, which 'should curb the buildup of domestic inflationary pressure.'
The central bank dropped a line from its previous report that there is scope for more slack to be absorbed before rate increases begin. Still, it retained its view that when the Monetary Policy Committee starts raising the key rate from a record-low 0.5 percent, the pace of tightening will be gradual.
The report highlights the dilemma for policy makers as they balance a strengthening economy and the need to move away from emergency policy settings against below-target inflation and subdued earnings. Data today showed earnings fell an annual 0.2 percent in the second quarter, more than the 0.1 percent the BOE had forecast.
'Uncertainty about how much slack there is has increased in recent months, in part reflecting labor-market outturns,' the BOE said. In light of this, the committee 'noted the importance of monitoring the expected path of costs, particularly wages, in assessing inflationary pressures.'
MPC Split
The MPC kept its benchmark rate at a record-low 0.5 percent last week. Speculation among forecasters is mounting that it is on the verge of a split, and the committee said today it has a 'wide range of views' on the amount of slack in the economy.
Before today's report, investors were betting the BOE would increase rates in February, forward contracts for the sterling overnight interbank average, or Sonia, showed.
The BOE now sees annual growth in wages in the fourth quarter at about 1.25 percent, down from 2.5 percent estimated in May. The projection for wage growth at the end of 2015 was cut to 3.25 percent from 3.5 percent.
The weak wage data contrasts with a strengthening labor market, with the unemployment rate falling to 6.4 percent in the three months through June. The MPC said these 'conflicting signals have underscored the uncertainty' about the level of spare capacity.
The BOE sees unemployment averaging 6.1 percent this quarter, down from 6.4 percent previously projected.
The committee also said the weakness in wages is consistent with 'higher labor supply, and hence more labor-market slack than previously thought.' It lowered its estimate for the current medium-term equilibrium unemployment rate to about 5.5 percent. That compares with a previous estimate that put the mid-point at 6.25 percent. It sees the equilibrium rate falling to 5 percent by the third quarter of 2017.
Economic Outlook
The BOE also forecast that the economy will grow 0.7 percent this quarter, and raised its full-year outlook to 3.5 percent from 3.4 percent in May. It also said inflation will remain below its 2 percent target through the forecast period to the third quarter of 2017.
'The expansion in output is projected to move to a firmer footing as productivity and real incomes revive,' the central bank said in the report. 'The remaining spare capacity in the economy is expected to be absorbed at a slower pace and in the recent past, and some slack is likely to persist for most of the forecast period.'
To contact the reporter on this story: Scott Hamilton in London at shamilton8@bloomberg.net
To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net Fergal O'Brien
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