Wage growth holds key to interest rates
British households are braced for a further squeeze on finances this year as wage settlements look set to disappoint despite the rising cost of living.
Economists expect UK wages to increase modestly in 2007 as the growing labour market – both from abroad and from pensioners returning to work – reduces workers’ bargaining power.
Low wage settlements will please the Bank of England and the Treasury but disappoint workers faced with record levels of inflation and the highest interest rates for five years.
Interest rates could rise again in the coming months as the housing market continues to boom and the economy shows further signs of strength.
Economist Malcolm Barr, of JP Morgan Chase Bank, said he, like the futures markets, expects interest rates to rise to 5.25% next month.
Howard Archer, of Global Insight, added: “There is undeniably a strong possibility that the Bank of England will lift interest rates to 5.25% in the first quarter as a precautionary measure, particularly if there is evidence that pay settlements are moving higher.”
That could spell bad news for homeowners already struggling to meet higher mortgage payments following similar interest rate rises in August and November.
It has also hit borrowers trying to pay off credit card bills and loans at a time of record levels of insolvencies in the UK.
However, the rate hikes appear to have taken time to filter through to the housing market with figures from the Bank of England showing that mortgage approvals in November were the highest for three years.
The Halifax said on Friday that prices fell 1% in December, but stressed that it was too early to call a turn in the property market after a 9.9% hike in the average cost of a home during 2006. It expects a rise of 4% this year.
Economist Ross Walker, of Royal Bank of Scotland, said that while the prospect of a rate hike was “skewed to the upside” the “main issue” for the Bank’s Monetary Policy Committee will be wage settlements.
The Retail Prices Index (RPI) inflation figure – used in many wage deals - stood at 3.9% in November, following higher food prices as poor harvests caused by warm summer weather took their toll.
RPI differs from the headline measure of inflation because it includes housing costs.
However, it is still closely watched by the Bank of England as resulting wage deals could put pressure on the now more commonly used measure of inflation - the Consumer Prices Index (CPI) – which was at 2.7% in November.
Mr Archer said he believed there was sufficient slack in the labour market to limit worker’s bargaining power and contain the wage increases.
He added: “The labour force is still growing rapidly due to the substantial inflow of migrant workers, a greater number of older people staying in the workforce, an increase in the number of previously economically inactive people now looking for a job and a growing working age population.”
There are also hopes that inflation could fall back to its 2% target level by the middle of the year. Although oil and energy prices will remain elevated, they are not expected to repeat the sharp increases seen through much of 2006.
The Bank of England is almost certain to leave interest rates unchanged on Thursday, but could act a month later to curb signs of a booming economy.
Chancellor Gordon Brown is forecasting growth of 2.75% to 3.25% this year, while the services sector – seen as the engine room of the UK economy – recently saw its strongest levels of activity for a decade.
Consumer confidence appears fragile, but fears of a wash-out Christmas for retailers look to have been wide of the mark.
Howard Wheeldon, senior strategist at broker BGC, said: “The more general UK economic outlook is still looking good for 2007, though the caveat of such positive thoughts for retailers must be that high levels of consumer debt are surely unsustainable.”
The decision for the Bank of England looks finely balanced, with the performance of the US economy likely to be a key factor. Industry leaders hope that the Bank adopts a wait-and-see approach, particularly as there have been signs lately that the strong pound is starting to impact orders.
The CBI believes rates should remain on hold until the autumn, when there will be the opportunity to cut the cost of borrowing.
Economist Philip Shaw, of Investec Securities, added: “We retain our view that we are currently at the peak in the UK rate cycle, despite interest rate markets looking for higher rates in the coming months.”
