“New economic speed limit” and inflation limit real wage growth

Sir Dave Ramsden’s speech to the Barclay’s Inflation Conference suggests a modest outlook for Britain’s savers

Brexit and the revising down of the UK’s growth projections has set a “new economic speed limit” according to the Bank of England’s deputy governor. The UK will continue to experience staid economic growth and limited wage increases Sir Dave Ramsden told Barclay’s Inflation Conference in a speech given on the 34^th floor of London’s Shard.

Detailing the task of balancing a 2% inflation target with a growth outlook impacted by pressured productivity and the ongoing distractions of Brexit, Ramsden said he expected GDP growth “to resume at a steady but unspectacular pace,” as demand moved from consumption and towards trade and investment. “Of course all this is conditional on a smooth transition to the eventual post-Brexit arrangements,” he added.

Tellingly, Ramsden said future wage growth would be based on inflationary pressures, rather than real growth in the economy. “Before the financial crisis we were invariably in a ‘two plus two is four’ world, with 2% productivity growth and 2% inflation yielding 4% wage growth at least. Today we seem to be in more of a ‘one plus two is three’ world: given 1% productivity growth, wage growth only needs to reach 3%, not 4, to be consistent with the 2% target. In our central forecast wage growth achieves that. And so although imported inflation falls back as the upward pressure from sterling’s depreciation comes to an end, domestic cost pressures keep inflation close to target in the medium term.”

The Bank of England’s wage growth projections have crept lower in recent years. Source: Bank of England

Such a state of affairs will be of little comfort to consumers who will see their wages grow only marginally ahead of inflation, effectively halving their ability to save above inflation and losing a quarter of wage growth in real terms. Indeed, Ramsden noted that the household saving rate has fallen by 2% of income.

The Brexit Elephant

The deputy governor and Monetary Policy Committee member described Brexit as putting the British economy in a “not just unusual but unique” position, with 40% of firms continuing to see it as a worrying source of uncertainty. The “imported inflation” caused by the vote to leave the EU has also had a lasting effect as the pound has fallen 15% from its pre-Brexit highs, making life more expensive for consumers: “The rise in import prices caused by sterling’s depreciation has had a material and persistent effect on incomes: real household income has only risen by 0.2% in the seven quarters since the referendum, compared with averaged growth of over 1½ % per year in the five years prior to it.”

Rates a double-edged sword

With GDP growth expected to resume at “steady but unspectacular pace,” Ramsden struck a cautionary optimistic tone in describing the Bank of England’s abilities to keep a lid on inflation via the forward planning of three rate rises over the next three years. Without such interest rate hikes, the forecast inflation would exceed the 2% target. “Instead excess demand and domestic cost pressures [would] build much more rapidly. And so inflation [would] stay persistently at around 2.4%, little changed from where it is now and materially above our inflation target.”

Rate rises will hope to keep inflation at 2%, despite low growth. Source: Bank of England

However, outside the conference one source very close to the UK’s debt management process, highlighted the Bank of England’s reluctance to call a definitive end to monetary policy or quantitative easing. Such money has made loans cheap and suppressed interest rates they said, pointing to those whose incomes and savings are pressured by inflation and who have taken out mortgages to buy into an inflated housing market. With rates at 0.5% a rise of just 1%, to 1.5%, would represent a tripling of interest costs for such debtors, they said. “Then what happens?”