Bank of England governor fires warning shot over pay
We take a
closer look at a recent speech from Bank of
Employees need to come to terms with a "temporary slowing" in the growth of their take-home pay, and pay-setters need to avoid a "self-defeating process of higher wages offset by higher prices". These were among the comments made by Mervyn King, governor of the Bank of England, in a speech made to the Birmingham Chamber of Commerce on 23 January 20071. Below, we examine his speech, which sheds light on the attention that the bank's Monetary Policy Committee (MPC) - which sets UK interest rates - is giving to pay growth as the 2007 pay bargaining round gets under way.
The issues at stake
To a much
greater extent than in recent years, pay growth - and particularly movement in
the level of pay settlements - is being described as a key factor in
determining the inflationary outlook for the
King explains high inflation
In his speech on 23 January, King chose to "write" the explanatory letter that he would have had to pen to the chancellor had consumer prices index (CPI) inflation risen above the 3% recorded for the year to December 2006. "Since we are so close to the level that would trigger the letter, let me instead write a letter to you," he told his audience. He identified three main factors behind the upward drift in inflation: the rapid growth of money and credit; increased inflation expectations; and cost pressures, including energy prices.
On the last of these points, King described rising labour costs as a major factor - particularly higher pensions costs. He went on to explore how the costs for employers and employees interact. "Higher pensions costs for companies, on the one hand, and higher taxes, petrol and utility prices for employees, on the other, have opened up a gap between increases in the paybill and real take-home pay," he said. "If investment and employment growth are to be maintained, the burden of these higher costs must either be passed back in the form of reduced input costs or forward as higher prices. So far, pay pressures have been subdued, but not sufficiently so to mitigate the rise in costs to employers. As a result, companies have scaled back their demand for labour and looked to raise prices," he explained.
He noted, however, that the ability to recruit migrant labour "continues to offer a safety valve for demand pressures in the economy, and is in some part responsible for the continued muted level of wage pressures". Nevertheless, he called on employers and employees to accept that their pay growth would not match inflation for the time being. "All of us - whether on the shopfloor, in the board room, or in the public sector - are coming to terms with the fact that those higher costs imply a temporary, but only a temporary, slowing in the growth of our real take-home pay. That adjustment - difficult but inevitable - will be helped by the fall in energy prices since last autumn," he added. "But the belief that we could avoid the adjustment by pushing up our pay would lead to a self-defeating process of higher wages offset by higher prices."
Outlook
In conclusion, King
left his audience with relatively tentative predictions for the inflationary
outlook, noting that it was "difficult to judge" how quickly inflation would
fall back over the next year or so. "All I can say is that the committee's
central view remains that inflation is likely to fall back in the second half of
the year, possibly quite sharply," he stated. With the majority of pay awards
settled in the first four months of the year, however - and the IRS panel of
forecasters expecting RPI inflation to average as high as 4.2% in the first
quarter of 2007 (see Datafile: 16 February
2007) - he may find that by then higher headline inflation will
already have made its mark on pay deals.
1.www.bankofengland.co.uk.
This article was written by Sarah Welfare, editor, Pay and Benefits, Employment Review, sarah.welfare@irseclipse.co.uk.
