Bank of England inflation target
Hoorah! Excluding bonuses, real wage growth has finally returned to the private sector. And despite a supposed wage freeze, even the public sector is seeing a modicum of inflation adjusted wage growth, ignoring publicly owned banks.
Mark Carney, Governor of the Bank of England, was understandably reluctant to declare the deepest squeeze in living standards since the 1870s finally at an end at Wednesday's Inflation Report press conference, but that was the clear implication of his forecasts. These posit that it is more likely than not that inflation will fall below 1pc in the next six months, that it won’t return to the 2pc target for three years, and that nominal wage growth next year will be back to 3.25pc.
Meanwhile, Britain’s jobs rich economic recovery continues apace. Nor is it any longer all about part-time work and self employment. Some 589, 000 full time positions have been added to the workplace over the last year. In down in the dumps France, it is universally believed that Britain’s superior economic performance is entirely down to cynical, electorally inspired measures to re-juice the housing market.
No doubt there is some truth in this judgment, but it is also as much a case of French sour grapes as anything else. The numbers are now so good that they cannot any longer be solely explained by a recovering housing market. Notwithstanding the political uncertainties and the deflationary vortex which is gripping much of Europe, even business investment is picking up strongly, and is now running well above trend. All good, then?
Relative to Europe, certainly, but the challenges remain daunting. What's more, clawing back lost ground on living standards is going to take an awfully long time. Polls show that that the public has grown weary of austerity. There’s no appetite for the still Herculean effort needed over the next parliament to close the budget deficit, and little likelihood of a government being formed with the political will to carry it through. Political crisis looks destined to takeover where economic crisis left off.
And that’s not the only deficit left to close. There’s also the yawning gap between what we spend as a nation, and what we earn – the current account deficit. With so little demand coming out of Europe, UK growth becomes ever more dependent on domestic spending and investment, widening the current account deficit and making the economy progressively more dependent on big inflows of foreign capital. That’s not a great position to be in if international trust in UK political stability were to take a sudden nose dive. A fully blown sterling crisis would make today’s low interest rate environment impossible to sustain.
Asked at today’s Inflation Report press conference whether he was a dove, a hawk, or even a Canadian loon, Mr Carney replied that he was a pragmatist. This is perhaps just as well, because as far as I can see, the Bank of England’s mandated inflation target has come to mean virtually nothing. When inflation soared in the early years of the crisis, the Bank begged us to “look through” all the inflationary pressures coming from a weaker pound and sky high commodity prices.
Mr Carney might argue that the same principle applies today, only the other way around. Over the next six months, it is more likely than not that he will be forced to write an “open letter” to the Chancellor explaining why inflation has fallen more than 100 basis points below target. That marks a change from the repeated letters Mervyn King was forced to write, explaining an overshoot, but it is still an awkward position to be in as head of an organisation whose main purpose is to anchor inflation at 2pc.
Mr Carney's view is that the shortfall is mainly down to disinflationary forces coming from abroad, alongside a somewhat stronger pound. These influences are not likely to go away any time soon, in the Bank’s judgement. Indeed, the Bank’s little fan charts show inflation barely achieving the 2pc target even at the end of the three year forecasting horizon.
Yet there few calls for the Bank to further ease policy to take account of the low inflation rate, and certainly no appetite for it on the Monetary Policy Committee. In part, this is because the Bank would in fact struggle to ease policy any further than it already has. Bank rate is already as low as it can realistically go, and everyone is very conscious these days of the potential downside of further QE. The Bank doesn’t want to go that route again. As for the even more extreme option of monetising the fiscal deficit – so-called “helicopter money” - you’ll be relieved to know that Mr Carney thinks there are no circumstances in which this might be appropriate.
In any case, the inflation rate no longer seems to dictate policy in quite the same way as it used to. Like the rest of us, Carney prays for a return to decent levels of real wage growth, and the sort of inflationary pressures interest rate policy is used to tackling. For the time being, the data seems to be going his way. Even so, rates on hold continues to be the order of the day; the point at which interest rates start to rise keeps on getting pushed ever further into the future. Hey ho.