A member of the Bank of England’s Monetary Policy Committee has warned that strong UK pay growth could limit the central bank’s ability to lower interest rates as much as expected this year. Megan Greene, one of the Bank’s top policymakers, said she is concerned that wages appear to be growing robustly again, which could hinder the fight against inflation.
In a speech in London, Greene noted that recent Bank of England surveys suggest employers are planning to hand out pay rises of 3.5% or more in 2023. This follows the latest official figures showing wage growth, excluding bonuses, weakened slightly to 4.5% between September and November, down from 4.6% in the previous three months.
Greene said a decline in wage growth “may have run its course”, posing a challenge for the Bank’s efforts to bring inflation back to its 2% target. Inflation reached 3.4% in December, up from 3.2% in November. The MPC member said she was “certainly sceptical” that productivity would rebound enough this year to offset the impact of consistent wage growth on inflation.
The Bank’s decision on when to next lower borrowing costs could also be affected by whether the US Federal Reserve cuts interest rates more aggressively than the Bank of England, Greene warned. This could cause US demand for UK exports to rebound, providing upward pressure on UK inflation.
The MPC member’s comments come as a separate Bank of England report concluded that the central bank had consistently underestimated the full effects of the inflation that followed the 2022 energy price shock caused by Russia’s invasion of Ukraine. The report found the Bank’s models had not anticipated the extent to which higher inflation in 2022 then led to households and businesses having higher inflation expectations, pushing for higher wages and adding to further inflationary pressures.
The Bank said it would try to improve its “modelling and understanding of key economic mechanisms, including the labour market, wage-price interactions and inflation expectations” to better comprehend the recent “inflation persistence”.
Additionally, a closely watched survey of UK business activity showed companies were reporting a sharp rise in costs in January, with the overall pace of inflation unchanged from December’s seven-month high. Businesses in manufacturing and services sectors were “overwhelmingly” linking rising costs to “elevated wage pressures”, along with increasing transport bills and raw material prices from suppliers.
These cost pressures have led firms to make the greatest increase to their own prices in more than a year, the survey found. It also showed a “steep loss” of jobs among many respondents, especially in the hospitality sector, which many companies attributed to the government’s introduction of higher national insurance contributions and increases to the “national living wage”.
The survey has led City economists to reduce their expectations of the MPC making two interest rate cuts this year, with the first quarter-rate cut now not expected until June. The current base rate is 3.75%, after four cuts by the MPC in 2025.
