This week a friend casually explained that he and his wife considered having a second child. But having recently moved into a new house, they were having to fork out a large share of their income on mortgage interest payments. Hearing talk of potential rate rises had therefore persuaded them not to risk another pregnancy.
Such are the life-changing impacts of decisions (or non-decisions) made by a group of men (and one woman) on the Monetary Policy Committee (MPC) of the Bank of England.
That morning the BBC had asked me to participate the next day in their 6.15 a.m. Business slot on Radio 4’s Today programme. The reason, the producer explained, was my known opposition to further Bank Rate rises. As I prepared to make the case that evening, Chris Giles of the FT tweeted that Mark Carney, governor of the Bank of England, had flip-flopped on the question of a rate rise.
“Financial markets” he was quoted as saying (were) “wrong to assume a UK interest rate rise in May is a foregone conclusion as softer economic data are giving the Bank of England pause for thought.”
This announcement came as a surprise to those active in foreign exchange markets (where sterling was promptly marked down). It should not have come as a surprise to anyone examining the latest British economic data.
First, let us consider wages growth, of concern not just to employees, but to the MPC whose primary “Monetary Policy Objective is to maintain price stability within the United Kingdom..” In its latest Inflation Report (published in February) the Bank’s staff assert that
“The cost of labour, and in particular wages, is the largest domestic cost facing most companies and hence is a significant driver of domestic inflationary pressures. The degree to which those costs affect in inflation will depend on growth in unit labour costs (ULCs) — the labour costs associated with producing a unit of output.”
Note that nominal wage growth before the Great Financial Crisis averaged around 4%. But that was then. Real wages have fallen in seven of the nine years since the global recession, and the OBR expects them to fall again in 2018. These are the numbers that explain Britain’s cost of living crisis. If we compare today’s average real weekly wage to that of 10 years ago, then on an annual basis, British workers are £880 worse off than they were in 2008. If comparisons are made between wages for the peak month of February 2008, and the same month in 2018 – then workers are £1800 worse off today than they were then. When the Coalition Government took office in May, 2010 real pay was £493 a week. Now almost eight years later it is £486 a week.
But back to today’s data. For nominal wages the rolling three-month average rose at 2.8% – a tiny fraction above inflation. But in February – the latest month of data for wages – the rate slipped back to 2.3% in the private sector. The only sectors that are doing materially better are ‘Finance & Business’ where on a rolling three-month basis, wages are rising by 3.5%. But even for this sector wages fell to 3% in February. For the low-paid – workers in retail and hotels – wages in February rose by a meagre 1.7%, and the three-month rolling average by 2%.
Given that the Bank of England believes that “the cost of labour, and in particular wages… is a significant driver of domestic inflationary pressures” – we can rightly assume that because wage rises are diminishing, these pressures are benign or dormant. The Bank’s Inflation Report researchers certainly think so: in February they expected inflation to be 2.9% in 2018 Q1, and then to fall back to 2.6% by Q4. The OECD agrees: “inflation is projected to remain moderate in the major economies” argued its staff in a November report.
And then the ONS published the Consumer Prices Index – and reported that the 12-month inflation rate had fallen to 2.3% in March 2018, down from 2.5% in February 2018.
Economists are now challenged by a range of ‘puzzles’. In addition to the long-standing ‘productivity puzzle’ there are now two more: a ‘falling inflation puzzle’ and a ‘falling wages’ puzzle. Why is inflation falling? And given that unemployment is low, why are real wages still low and in some cases, falling? Economists do not know the answers to these questions.
Policy makers have long believed that if unemployment falls below a certain point, then wage inflation will begin to rise and that this point represents a so called ‘natural’ rate of unemployment (more specifically the non-accelerating inflation rate of unemployment (NAIRU). But unemployment and real wages have fallen together! And still there is no sign of inflation rising. Levels of employment are as full as Britain has had since 1975. Unemployment has been below 5% the last 18 consecutive months. And yet pay in February did not rise: instead, as noted above, it slipped back to 2.3%.
There should be no puzzle. Common sense tells us why wages are low. Thanks to attacks on trades unions and on the power of workers to collectively negotiate wages, employers are today far more powerful than they were before the 1984-5 Miners’ Strike. They are now in the position that Mrs Thatcher and her government fought for and can dictate low and falling wages. Joan Robinson, a distinguished Keynesian economist, identified this one-sided market power way back in 1933. She defined it as monopsony in her book The Economics of Imperfect Competition. In the absence of effective bargaining powers for workers, employers can now command wage rates.
While this may be a profitable strategy for individual firms and their shareholders, it is dangerous for an increasingly fragile British economy.
One of the reasons is this: thanks to low and falling wages, there is no growth in spending. Retail sales are down in volume terms, because of the impact of the depreciation of sterling, and the rise in import prices. Higher prices meant that spending in the retail sector is unchanged from the year before. And as Reuters reports, “British shoppers stayed home in March as they felt the chill from the ‘Beast from the East’, leading to the biggest quarterly fall in retail sales in a year.”
Yet another danger lies in the growth of UK household consumer credit, which, according to the Bank of England grew 9.3% over the last year – no doubt to compensate for low or falling real wages. The FCA explains that “1 in 5 mortgages today are interest only mortgages, many of which were made at the height of the credit boom to borrowers with little equity in their homes and not a lot of disposable income. And they won’t mature until about 2032.” Total credit lending to individuals is currently very close to its September 2008 peak – according to the FCA. And we know what happened then.
“There are a significant number of households that are in so deep that the slightest sign of rough weather could see them in over their heads,” said Jonathan Davidson, one of the FCA’s directors of supervision.
Given these imbalances, the biggest danger facing the British economy is this: at their meeting in May the Monetary Policy Committee of the Bank of England is very likely to raise rates – despite a warning from the governor – because of the ongoing fear of inflation. (Andrew Sentence, an ex-MPC member tweeted this week that it is “Quite likely that all 4 external #MPC members will vote for a May rate rise. Can they get 1 or 2 internal votes to support them? If Carney is opposed, Broadbent and Haldane are main candidates to push through a rate rise – so watch their statements in the next week or so.”)
If Andrew Sentence is right, MPC members will raise the Bank Rate despite the dangers listed above – and after signs of instability and volatility in the global economy. (Several of the many bubbles in the ‘frothy’ global economy recently burst, including Bitcoin which at the end of 2017 traded at nearly $20,000 and then collapsed to less than half the value at its peak. The recent short-selling of the Volatility Index on Wall St. caused major losses to what are known as Exchange Traded Funds. And there are several other financial bubbles at risk of implosion – including the bubble in corporate debt; the valuations of FAANGs (Facebook, Amazon, Apple, Netflix and Google) and the bubble in Tech stocks.)
Ten years after the Global Financial Crisis, little has been done to restructure the flawed international and domestic financial system. Global imbalances (in trade, exchange rates and the financial sector) and domestic imbalances (including inequality) have intensified, not diminished. It is as if we have learnt nothing from the crisis. As a result, both the global and the British economy remain fragile.
Raising Bank of England rates at this point of fragility, would be like deliberately and repeatedly pointing a sharp dagger at a bubble of household, corporate and financial debt.
It might even cause birth rates to fall, as parents like my friend prioritise higher interest payments on their mortgage – over hopes for another child