Tuesday, January 16, 2007

The headline inflation rate is up to 3%, a full percentage point above the target rate. It is now easy enough to understand the interest rate hikes of recent months. While much of the underlying activity suggests that this is a blip - oil prices have fallen back since they hit their peak, there has been a slowdown in industrial prices - the Monetary Policy Committee has been right to be cautious. (And with hindsight I now think that I, along with the minority of MPC members who did not vote for the interest rate hike in November, was wrong to want to hold the interest rate at 4.75% at that stage).

Will there be further increases in the interest rate? Possibly. The MPC will need to watch very carefully for signs of inflation feeding through into higher wage increases. The first signs, earlier this month, were that such a feed-through is indeed happening, but these settlements were in the idiosyncratic pharmaceuticals industry. A clear message from the Bank of England now, to the effect that further increases will become inevitable if there is no wage restraint, could do much to help.

Thursday, January 11, 2007

Today's interest rate rise, to 5.25%, follows the news earlier this week about high wage deals being struck in the last few days. As I have written before, it is far from clear that these recent deals are symptomatic of a general trend for higher wage settlements, but it is clear that the Monetary Policy Committee has seen enough to persuade them that they need to pursue an aggressive stance. Hopefully by hiking rates now, the need for further increases can be avoided.

Monday, January 08, 2007

Today's report by Income Data Services suggests that pay inflation is starting to cause a problem for the UK economy. In January so far, the median level of pay awards has been of the order of 4%, well above the rate of price inflation.

Firms can finance pay increases in a number of ways. Productivity gains are the most attractive. If a firm awards a wage increase in excess of the rate of productivity growth, however, it must find some other way of funding the hike - price increases, which themselves fuel inflation, are an obvious option.

The recent data suggest that negotiators are starting to build inflation into their pay awards, and if this is true then the Bank of England's Monetary Policy Committee will need to consider further interest rate hikes in order to bring inflation back down to target levels.

So far, the evidence is little more than anecdotal. The pay awards have been led by pharmaceutical firms where productivity gains over the last couple of years have been substantial. New drugs such as Abilify and Viagra have generated new markets for these employers, and have therefore allowed them to make pay awards which, in themselves, may not be inflationary. For several years now, the chemical industry (of which pharmaceuticals is a part) has been a strong performer in the UK in productivity terms. What is key now is how other employers respond.