Bank of England slashes wage growth forecasts

The Bank of England Quarterly Inflation report released this morning confirmed expectations that the Bank would downward-revise wage expectations while upward revising employment levels.

The Bank downward-revised its wage growth expectations to 1.5 percent, a big change from its May forecast of 2.5 percent, forecasting a continued decline in real wages. The downward revision follows the UK labour data this morning which showed that, while overall unemployment levels have declined to 6.5 percent, wage growth has moved into negative territory. Second quarter pay including bonuses declined by 0.2 percent year-on-year, while pay excluding bonuses rose by 0.6 percent.

The BoE underlined that slack remains at the heart of any future rate hike decision, but that it would be looking to wage data as part of that assessment alongside overall employment volume.

The Inflation report clarified its estimate of slack at 1 percent, previously stated at 1-1.5 percent, but iterated that this is to address interpretations that the MPC's views were within this range. Instead it said that the 1 percent level should be read as 1.25 percent.

Wages

The Inflation Report attributes some weakness in wage rises to the likelihood that the employment gap was bigger than previously thought in the first quarter and through 2013, however the gap is estimated to have narrowed over the first half of 2014. BoE surveys suggest that the wages employers are paying to hire new recruits are rising faster than average pay, which may feed through to later average wage growth.

Slack

The report states that there is greater uncertainty around the margin of slacking the labour market than in the May report. It notes that while continued robust growth in employment and hours suggests that slack is narrowing more quickly than the MPC had expected, the continued and unexpected weakness in wages suggests otherwise.

Inflation prospects

Alongside the projected continuing decline in unemployment, over the BoE forecast period, an anticipated modest expansion in supply should hold down the build-up of domestic inflationary pressure. Sterling strength is expected to feed through to a pull down of CPI inflation through weaker import prices. Inflation expectations remain anchored to the Bank's 2 percent target.