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The Bank of England hiked its rate 25bp to 4.25% today:

Consumer prices rose 10.4 percent in February from a year earlier, up from 10.1 percent the month before, ending a three-month downward trend and stubbornly keeping inflation in the double digits, according to data from the Office for National Statistics published on Wednesday.
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Earlier on Thursday, the Swiss National Bank, the country’s central bank, raised interest rates by half a percentage point, to 1.5 percent, to counter “the renewed increase in inflationary pressures” in Switzerland.
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The Bank of England forecast that the inflation rate would fall significantly this year, and average about 4 percent around the end of the year. In fact, inflation should fall more than expected in the second quarter of this year because of the government’s decision to extend its subsidy for household energy bills for an additional three months to the end of June. And wage growth has been weaker than expected, easing policymakers’ concerns that high wages in the private sector would make it harder to return inflation to the bank’s 2 percent target.
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Andrew Bailey, the governor of the central bank, told reporters after last month’s meeting that there had been a “turning of the corner” on inflation but warned “it’s very early days, and the risks are very large.”

To some extent, those risks materialized in the surprising upturn in Wednesday’s data, which showed food prices rising in February at their fastest pace in 45 years and a measure of services inflation increasing. This week’s meeting showed the challenge the bank faces in determining the path of inflation.

The increase in inflation, which was 0.6 percentage points higher last month than the central bank expected, came from rising food prices and higher prices for goods, namely clothing and footwear.

Speaking of rising wages, Christine Lagarde had a few words yesterday:

For the seven countries covered by the ECB’s wage tracker, collective bargaining during 2022 led to an aggregate wage rise of 4.7% for this year. This is already playing a stronger role in core inflation. While wage-sensitive items contributed only around 0.5 percentage points to core inflation before the pandemic, that contribution has more than doubled in recent months.

If both workers and firms accept fair burden sharing, and stronger wage growth represents merely a rebalancing between labour and capital, then both wage and price pressures should diminish as this process plays out. But if both parties attempt to unilaterally minimise their losses, we could see a feedback mechanism between higher profit margins, wages and prices.

The risk of such a “tit-for-tat” dynamic is also heightened by the prospect that labour market tightness will
linger.

Unlike other jurisdictions, labour participation in the euro area has grown robustly since last year, helping to address part of the soaring labour demand driven by reopening. But the pandemic has also led to a sharp increase in public employment, reducing the pool of labour available to the private sector. And how much further labour supply can expand overall will depend, among other things, on complex policy questions such as countries’ attitudes to immigration and childcare.

At the same time, the unemployment rate is at a historical low and, in some countries, it is so low that it
will be increasingly difficult to recruit from the remaining pool of labour.

All this means that we could see a more prolonged cost-push shock coming from wage growth. This is unlikely to prevent goods disinflation, since wages represent only around 20% of direct input costs for manufacturing firms. But wages make up around 40% of direct input costs for services providers, and services inflation accounts for almost two-thirds of core inflation.

In parallel, firms’ profit margins continue to grow, in part because some are taking advantage of supply-demand imbalances to test consumer demand with large price increases – over and above their increase in costs. But in the absence of a persistent rise in market power, this can only continue insofar as demand remains resilient. Otherwise, firms will have to absorb cost increases in margins and price pressures will start to ease.

This entry was posted on Thursday, March 23rd, 2023 at 6:32 pm and is filed under Market Action. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.