ON A recent trip to visit some companies in the north of Scotland, I learned about the fortunes of different businesses. On one hand, I learned about the opportunities for wave and tidal power in the area. In contrast, people I met in Invergordon spoke of the town being affected by the cuts to oil investment that have followed the sharp fall in oil prices since mid-2014. Oil has clearly retained its ability to shock.
The lower oil price has, however, provided some relief to others in Scotland, most importantly to households but also to businesses that use oil heavily – a reminder of the trade-off between the fortunes of different parts of the economy. From the perspective of the overall inflation rate, cheaper oil is one of a sequence of unexpected factors that has helped to push inflation down, away from the Bank of England monetary policy committee’s 2 per cent target. Past experience has suggested that such shocks can run for some time.
But looking further ahead, there are good reasons to think that inflation will return to target. For me, pay growth is the most important area to watch. The recent news of a 4 per cent pay rise from Sainsbury’s, together with the new national living wage, for example, add to the sense that wages are stronger than the MPC had expected in the spring.
Faster productivity growth means that more can be produced without firms having to hire more workers at higher pay rates; so the 1 per cent growth of productivity that we witnessed in the second quarter this year was a welcome antidote to seven lean years. But it is too early to treat it as a permanent change for the better.
So with wage growth remaining firm, the tightening labour market means that inflation is likely to rise above target in two to three years’ time. Policy needs to be set with reference to this, rather than the current rate of inflation. As a result, it seems likely to me that the bank rate will need to rise relatively soon.
But the precise path of interest rates will depend on the state of the economy, which is uncertain. And it is possible that, if events turn out very differently, a path of gradual rate rises might have to be reversed somewhat. For me, a fear of costs associated with such a change of direction should not lead us to hold back from changing bank rate. If we were to delay raising rates until the probability of a subsequent reduction seemed extremely low, we would almost certainly have waited too long, and would risk letting inflation drift significantly beyond our 2 per cent target.
I will continue to monitor carefully developments both at home and abroad, taking account of possible effects of events in China. Any decision to vote to change bank rate will be made on the basis of the balance of risks, but with the comfort that, if subsequent developments mean that any increase needs to be reversed, that can be done. «
Martin Weale is an external member of the Bank of England’s monetary policy committee