New School Rules Labor-Market Thinking in BOE Policy Debate

  • Jobless rate slide shows officials may run labor market hot
  • Data-focused policy maker wants increase to fend off inflation

Labor-market data is becoming a sticking point among Bank of England interest-rate setters.

Having let joblessness slide to a seven-year low of 5.4 percent, Governor Mark Carney and colleagues are still debating how far it can fall before they need to respond with higher rates. Divisions over how the financial crisis has shaped interpretations of the data are sharpening differences among officials at either end of the debate.

Leading the charge for higher rates is Ian McCafferty, who has been seeking to increase the British benchmark from 0.5 percent since August, only to run into opposition from the eight other members of the Monetary Policy Committee.

His concern is that, unless checked, a tighter labor market will spark higher wage demands which companies will then pass on, forcing up inflation. While consumer prices fell 0.1 percent in September, a measure that strips out more volatile elements rose 1 percent and the latest available wage data shows a strong pick up.

Opposers of his view raise doubts over whether the traditionally strong relationship between unemployment and inflation still exists. The key question, which is also being asked in the Federal Reserve, is whether the crisis fundamentally changed the economy, leaving it prone to weak economic growth and inflation which require an extended period of easy monetary policy.

Among those exploring that puzzle is the BOE’s chief economist Andy Haldane, who said in September that the case for lifting rates is still “some way from being made.” He noted unit-wage cost growth is still a percentage point below the level needed to reach the central bank’s 2 percent inflation target.

New School

“Doves, like Haldane, don’t seem to necessarily disagree about the strength or weakness of incoming data, but more about what it means for the future,” said Steve Barrow, head of Group-of-10 strategy at Standard Bank Group Ltd. in London. “He, and others are more prepared to let the unemployment rate fall significantly below the full employment rate than the likes of McCafferty.”

Investors are siding with what Barrow calls Haldane’s “new school” approach by betting the BOE will be on hold until 2017 as wage growth stays muted.

The risk is that financial markets are “extremely vulnerable should the ‘old school’ start to gain the upper hand,” said Barrow. “We can’t be sure that this will happen but, as long as the risks persists we remain a bit wary of any recovery in global asset prices, such as stocks.”

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