Carney's New U.K. Labor Market Theory Passes First Wage Test

  • Statistics office says labor market is near ‘full capacity’
  • Jobless rate stays the same as wage growth falls slightly

Mark Carney

Photographer: Chris Ratcliffe/Bloomberg

Mark Carney’s theory that more Britons can be in work without pushing up wages just cleared its first hurdle, but the real test may come later this year.

The Office for National Statistics said Wednesday that the unemployment rate remained at 4.8 percent in December, while pay growth slowed slightly to 2.6 percent, weaker than economists had forecast. The figures are the first on the labor market since the Bank of England governor lowered his estimate of the rate that unemployment can fall to without fanning wage gains and inflation.

With employment already at a record, the risk for the BOE is that it falls behind the curve if the labor market continues to tighten. The bank kept rates unchanged this month even though the pound’s drop since the June vote to quit the European Union is set to jack up inflation. Policy makers expect price growth to exceed the central bank’s 2 percent target as early as this quarter.

“The BOE will take some heart in this data, but it will be some time before their judgment is really tested,” said Dan Hanson, an economist at Bloomberg Intelligence in London. While he expects the BOE to stay on hold for at least two more years, “ultimately, it will be a firming of domestically generated inflation that will be the catalyst for a move to higher interest rates.”

Investors now see a 20 percent chance that the BOE will raise its benchmark rate from a record-low 0.25 percent by the end of this year, compared with a 48 percent chance at the beginning of February.

Wage growth will be key for monetary policy in the coming months, and there are divisions among the Bank of England’s rate-setting committee about how it’s likely to evolve.

The Monetary Policy Committee reduced its estimate of the equilibrium unemployment rate to 4.5 percent from 5 percent on Feb. 2 due to changes in the labor market such as more flexible work and demographic trends, suggesting there would be “less impetus” to wage growth over the next three years.

Policy maker Kristin Forbes said shortly thereafter that the economy may soon need a rate increase, and that while she also thinks the equilibrium rate is lower than 5 percent, it’s not as low as 4.5 percent. She said that wages could pick up alongside inflation.

“With both pay growth and unit wage costs still below the level consistent with 2 percent inflation, the concerns among some of the more hawkish members of the committee are likely to have been allayed for the time being,” Hanson said.

Policy makers reiterated this month that while rates could respond to economic developments in either direction, the above-target inflation is unlikely to get out of hand because of the greater slack in the labor market. Wednesday’s data confirm that view of the economy so far, though the statistics office also said that the jobs market is near “full capacity.”

“The lower-than-expected wage number makes a rate hike a slightly more distant prospect,” Alan Clarke, an economist at Scotiabank in London, said by phone. “Yes, inflation is going to overshoot the target, but only temporarily, and it’s due primarily to imported inflation, not domestically-generated inflation.”

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