Photographer: Christopher Furlong/Getty Images

Stagnant Wages Should Stay the Bank of England's Hand

Stagnating wages should deter the central bank from raising rates.

Bank of England policy maker Kristin Forbes suggested on Tuesday that the need to restrain inflation might "soon suggest an increase" is required in interest rates. The central bank's latest survey of businesses, however, suggests weakening pay growth should persuade the bank to keep borrowing costs on hold.

The bank's regional agents regularly survey about 700 businesses around the U.K. The most recent round-up, published on Wednesday, shows an alarming drop in expectations for wage growth. As the chart below illustrates, companies are expected to increase wages by an average of 2.7 percent in 2016, as shown by the yellow diamond. For this year, though, the prediction has dropped to just 2.2 percent (the green diamond):

Source: Bank of England

Combine that with the Bank of England's forecast that inflation will accelerate past its 2 percent target this year, and it's clear that Britons face wage stagnation. In the survey detail, companies said economic uncertainty is expected to restrain pay rises, offsetting difficulties in recruiting and retaining staff.

These regional surveys have been a pretty good predictor of what wages will do. They've certainly been more accurate than the Bank of England's own estimates, which have consistently overestimated wage increases by as much as 1.5 percentage points in the past few years.

The central bank left its key interest rate unchanged at 0.25 percent when its monetary policy committee met last Thursday. Since that meeting, traders have scaled back expectations for how high interest rates might rise in the coming three years:

Scaling Back Rate Expectations

Market expectations for Bank of England policy rate

Source: Bloomberg MIPR function

The derivatives market sees less than a 25 percent chance of an interest rate increase this year; you have to go all the way to the bank's August 2018 meeting before the likelihood rises past 50 percent:

Rates on Hold

Likelihood of a Bank of England rate increase at future meetings

Source: Bloomberg's WIRP function

As I wrote last week, the Bank of England is right to allow inflation to surpass its 2 percent target for a while. Consumer price gains have been so low for so long -- inflation averaged just 0.1 percent in 2015 and 0.6 percent in 2016 -- that a period of above-target price gains is warranted. And with pay stagnating, keeping borrowing costs on hold is the key contribution the central bank can make to preventing Brexit uncertainty from undermining consumer confidence.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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