Inflation risks rise as wage disinflation stalls, BoE’s Greene warns

“wage disinflation has stalled,” Bank of England (BoE) Monetary Policy Committee (MPC) member Megan Greene said on Tuesday. Her remarks suggest pay could start driving prices higher.

With the risks now “greater than we thought,” Greene reiterated her view: “We [the BoE] should proactively lean against the risk of second-round inflation effects,” she said.

Ahead of the UK inflation figures due the following day, Greene stressed that the slowdown in wage growth appears to have stopped at levels above the BoE’s goal.

TMGM Analysis: Financial Market News, Economic Calendar & Market Insights

Main points:

The slowdown in wage growth has come to a halt

Still believe pre-emptive action is needed to counter the risk of second-round inflation effects

Second-round effects pose a greater risk than previously thought.

3.5% pay growth is more in line with forward-looking indicators

2% inflation remains inconsistent with the levels at which wage disinflation appears to have stalled

Economic resilience has exceeded expectations

Slack in the labour market may already have peaked

BoE: key questions answered

The Bank of England’s role and its impact on the Pound

2% is the Bank of England’s (BoE) target for a stable inflation rate. Setting monetary policy for the United Kingdom, the central bank’s main objective is ‘price stability’. It pursues this by adjusting base lending rates. By deciding the rate charged on loans to commercial banks and on lending between banks, the BoE determines interest rates across the wider economy. The value of the Pound Sterling (GBP) is also affected.

Sterling’s response to Bank of England monetary policy

Above-target inflation prompts the Bank of England to increase interest rates, raising borrowing costs for households and businesses. Higher rates support the Pound Sterling by making the UK a more attractive destination for international investors’ funds. Below-target inflation, by contrast, signals slower economic growth. The BoE will then consider rate cuts to reduce credit costs, hoping businesses will borrow to fund projects that generate growth. This weighs on the Pound Sterling.

Quantitative Easing (QE): implications for the Pound

When interest rate cuts cannot deliver the required outcome, the Bank of England can turn to Quantitative Easing (QE) as a last resort in extreme circumstances. The policy substantially expands credit flows through a stalled financial system. To implement QE, the BoE prints money and purchases assets from banks and other financial institutions, typically government bonds or AAA-rated corporate bonds. The Pound Sterling usually weakens as a result.

Quantitative tightening (QT): implications for the Pound Sterling

As the economy strengthens and inflation begins to rise, quantitative tightening (QT) reverses QE. Under QE, the Bank of England (BoE) buys government and corporate bonds from financial institutions to promote lending. Under QT, it instead ends further bond purchases and no longer reinvests principal repaid when bonds in its existing holdings mature. This usually supports the Pound Sterling.