Financial institution of England governor says Britain is dealing with a wage-price spiral

A sign displays the price in pounds sterling of food, including pickles, at a fruit and vegetable market in a stall in east London March 31, 2023.

Susannah Ireland | Afp | Getty Images

LONDON – After more than a year of warnings, Bank of England Governor Andrew Bailey says the UK is now experiencing a wage-price spiral despite 12 consecutive interest rate hikes by the central bank.

“Part of the strength of core inflation [in the U.K.] reflects the indirect effects of higher energy prices,” Bailey said in a speech on Wednesday. “But it also reflects second-round effects as the external shocks we’ve seen interact with the state of the domestic economy.”

“If headline inflation falls, these second-round effects are unlikely to go away as quickly as they emerged.”

Among those sticky areas, he continued, are domestic wage growth and price setting.

This situation poses the risk of a wage-price spiral — a theory that suggests that when inflation rises, workers negotiate wage increases, which boosts demand and pushes firms to raise prices to offset higher spending. This, in turn, means that workers need higher wages to be able to afford goods and services – leading to so-called “second-round effects”.

UK inflation surprised economists when it was above 10% in March. Core inflation, excluding food, energy, alcohol and tobacco, was stable at 5.7% month-on-month.

Bailey said the easing of the labor market is progressing at a slower pace than the central bank previously expected as job vacancies begin to fall.

He noted that nominal wage growth – not adjusted for inflation – and service price inflation had been in line with the bank’s forecasts. The Bank of England sees signs of slowing wage growth but is observing that service sector inflation remains high, Bailey added.

The bank’s Monetary Policy Committee “remains of the view that inflation risks are significantly skewed to the upside,” he said, and would further adjust policy rates “as needed” to meet the 2% inflation target.

Unique risks

Bailey was met with backlash in February last year when he said companies should show “restraint” when negotiating wages and that workers “broadly” should not demand large wage increases. His comments were called unrealistic at the time as the public faced a growing cost-of-living crisis and inflation was leading to a sharp fall in real wage growth.

Economists and policymakers in the EU and US have said in recent months that they no longer see any significant risk of a wage-price spiral in those economies, as wages still have room to scale with inflation and historical stagnation to keep.

Many also say there are signs that companies have been raising prices above inflation in their input prices, which has protected corporate profit margins.

Alberto Gallo, chief investment officer at Andromeda Capital Management, previously told CNBC that the UK is the developed economy hardest hit by factors including weakness in the British pound, reliance on food and energy imports and a tight labor situation at risk of a wage-price spiral, the market is restricted by post-Brexit rules.

Huw Pill, the Bank of England’s chief economist, sparked similar excitement last month when he said on a podcast that there was a reluctance in Britain to accept that “we’re all worse off, we all need to get our share.” and that workers and companies must stop passing price increases on to each other.

“If what you’re buying has gone up a lot compared to what you’re selling, you’re going to be worse off,” Pill said.

“Somehow someone in the UK has to accept that they are getting worse off and stop maintaining their real purchasing power through price increases, whether that be higher wages or passing energy costs on to customers.”

Addressing the backlash, Pill said in comments quoted by Reuters earlier this week that he “would probably use slightly different words”.

Still, he continued, “I understand that this is a bit of a difficult message to send, but … having to pay more for what we buy from the rest of the world than what we sell to the world is a problem.” put pressure on our purchasing power.

Comments are closed.