Wage growth set to keep interest rates low

Bank of England. Photo: Yui Mok/PA Wire Bank of England. Photo: Yui Mok/PA Wire

Monday, July 21, 2014
9:46 AM

Slow wage growth will keep the Bank of England from raising interest rates this year despite a run of strong economic data, according to an influential report.

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The EY ITEM Club said in its latest quarterly survey that despite unemployment falling to its lowest level since 2008 and wage inflation at its lowest for a decade, it expects rates will not rise until the first quarter of next year.

Its chief economic adviser Peter Spencer said: “The markets are jumping the gun in thinking that rates will rise this year. Low inflation, the strong pound, and ongoing risks from the eurozone, all suggest caution in raising rates.”

The report forecasts that real incomes “will recover slowly” growing from 1.8% in 2014 to 2.2% in 2016. This contrasts with inflation which unexpectedly jumped to 1.9% from 1.5% last month.

The survey also expects investment in the housing market to rise from 7.6% this year to 13.4% in 2016 as an industry buoyed by measures such as the government’s Help to Buy gains confidence.

But because of a shortage of housing stock the report estimates house prices will jump 9.1% this year, 7.4% next year, before slowing to 4.2% in 2016.

Mr Spencer added: “Investment in our housing stock is much lower than it needs to be in order to put a roof over the head of the UK’s growing population.”

However, the survey forecasts that UK economy will grow faster this year than any country in the G7 pool of developed nations.

The report said the UK will grow by 3.1% this year, driven by business investment rather than consumer spending as has been the case up to now.

This compares with GDP growth forecasts this year of 1.8% for Germany and 2% for Canada.

The spur of this growth in the UK will be capital spending by business, which is set to jump by 12.5%, the report said.

Mr Spencer said: “What a difference a year makes. Last summer any growth looked better than no growth and the outlook remained uncertain.

“But, confidence has now returned and economic uncertainty has dropped well down the worry list.”

The survey thinks the good news is set to continue, forecasting that the jobless rate will fall from 6.8% in the first quarter of this year to 5.6% by the end of 2015.

Mr Spencer added: “Business investment is being ramped up generating over half of the growth over the last year and helping to rebalance the economy away from consumption.

“Underpinned by a strong labour market that provides the best of both worlds - boosting incomes via employment rather than wages, while keeping inflation low - the UK economy has hit the sweet spot.”

Mark Gregory, chief economist of accountancy firm EY, adds: “After several false starts, this time it could be different.

“Although the consumer remains an important part of the story, stronger corporate confidence in future demand is driving fixed investment. After several years of low expenditure there is a significant amount of catching up to do.”

The report forecasts the UK economy will enjoy “a perfect combination” of consumer spending financed by strong employment, rather than wage growth and borrowing, accompanied by low inflation and low interest rates.

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