Photographer: Simon Dawson/Bloomberg

What Productivity Gloom Means for the Bank of England

Office for Budget Responsibility throws in towel on U.K. potential growth
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U.K. Chancellor of the Exchequer George Osborne’s budget this week came with some nasty economic projections that may have implications for Bank of England policy.

The Office for Budget Responsibility outlined a pessimistic view of productivity and downgraded its forecasts for earnings growth. Taken together, it suggests Britons will be poorer than previously thought and that costs pressures remain tightly screwed down, giving BOE officials another reason to keep interest rates at a record low.

While the Monetary Policy Committee has repeatedly said it's optimistic that productivity can recover from the financial crisis, that view was dealt a blow as OBR Chairman Robert Chote signaled his organisation is losing faith. And the potential for the economy to grow affects everything: gross domestic product, the likelihood that pay will rise, company profits and tax revenues.

In its February Inflation Report, the BOE said the outlook for supply and wage growth depends “fundamentally on the productivity of the workforce.” While that’s currently being depressed by temporary factors, it will pick up gradually as those dissipate, the central bank said.

So the BOE’s nine-member rate-setting panel -- which has kept benchmark borrowing costs at a record low for seven years -- may be troubled by the OBR’s prognosis.

Deputy Governor Minouche Shafik said last year she wants to faster wage growth relative to productivity before she’ll vote for an interest-rate increase.

``My view is that one is looking for wage growth between 2-3 percent above productivity,'' she said. 

“Not all of the weakness in inflation can be explained by the price of things we import -- a portion of the current deviation from target is due to weakness in domestically generated inflation,” Shafik said in a speech in December.

Based on the information from the OBR, Shafik will be waiting a while. In fact, she’ll need a new term of appointment to vote for a hike, with her current one ending in July 2019.

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