Photographer: Luke MacGregor/Bloomberg

Carney's Inflation Equation Heats Up as Stores Plan Price Hikes

Consumer inflation expectations are on an upward trend
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Mark Carney has his eye on inflation expectations and, crucially, whether they'll lead U.K. workers to demand bigger wage increases.

Just this week, the Bank of England governor said it’s a key part of how policy makers assess how long they can keep interest rates at a record low in an economy that’s growing faster than expected. New figures show that at least some parts of the equation are falling into place. 

Citigroup's measure of consumers’ long-term inflation expectations rose to a two-year high in February. While the level — 3.2 percent — may not spark great concern at the BOE just yet, it’s got what Citi says is "sustained upward momentum." Here's its analysis:

"We cannot rule out second round effects when households and businesses negotiate wages and rents, perpetuating higher inflation beyond the current spike."

Separately, Barclays said all of its inflation-expectation measures are picking up and the ascent is "potentially less transitory than previously thought." Reinforcing that view, figures from the Confederation of British Industry show that retailers are planning to jack up prices by the most in six years. That’s their response to a squeeze on margins from a higher minimum wage and the weaker pound driving up the cost of buying goods from overseas.

The surge in the retail-price index and the increase in inflation expectations highlight one of the most dramatic repercussions of the Brexit vote on households. With the pound down 16 percent since the June vote to leave the European Union, import costs are surging at the fastest annual pace in nine years and consumer-price inflation is accelerating. It's something the BOE can't ignore, according to Carney:

"One of things we are really looking at will be are there be any second-round effects, labor-market effects? Are people demanding higher wages because they’re seeing higher prices in the shops? Entirely understandable."

But while all this could have, in Carney’s words, “consequences for the path of policy,” he reckons Brexit and other concerns will keep pay growth in check. According to the BOE Agents’ Survey, which the governor says has "decent predictive power," there will even be a deceleration to 2.2 percent this year from 2.7 percent.

"One can only explain that by some degree of uncertainty and the balance of bargaining power shifting a bit more to employers from workers in this environment of uncertainty," Carney said.

As Carney finds reasons to keep the benchmark rate at 0.25 percent, traders are listening to him. Bets on a hike by the end of the year fallen by more than half — to 18 percent — this month.

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