Despite twelve consecutive central bank interest rate hikes, Bank of England Governor Andrew Bailey has warned that the UK is experiencing a wage-price spiral. Bailey stated that “some of the strength in core inflation [in the UK] reflects the indirect effects of higher energy prices,” but also noted that it reflects second-round effects. He further explained that these second-round effects include domestic wage growth and price setting. According to Bailey, this situation risks a wage-price spiral, where workers demand wage increases as inflation rises, leading to higher demand and pushing companies to increase prices to compensate for steeper expenses. This creates a cycle where workers require higher wages to afford goods and services, perpetuating the “second-round effects.”
UK Inflation Rate
The UK inflation rate was above 10% in March, surprising economists. Core inflation, which excludes food, energy, alcohol, and tobacco, remained steady at 5.7%. Bailey said that the loosening of the labor market, as vacancies begin to fall, is happening more slowly than the central bank previously anticipated. While the Bank of England sees signs of a slowdown in wage growth, Bailey noted that nominal wage growth and services price inflation occurred in line with the bank’s forecasts. The bank’s monetary policy committee continues to judge that the risks to inflation are skewed significantly to the upside and will adjust its main bank rate as necessary to reach its 2% inflation target.
Risks of a Wage-Price Spiral
Economists and policymakers in the EU and US have said in recent months that they no longer see significant risks of a wage-price spiral in those economies, with salaries having room to rise to catch up with inflation and historic stagnation. However, Alberto Gallo, chief investment officer at Andromeda Capital Management, previously told CNBC that the UK was the developed economy most at risk from a wage-price spiral because of factors including weakness in the British pound, reliance on food and energy imports, and a tight labor market constrained by post-Brexit rules. Huw Pill, Bank of England chief economist, sparked a similar controversy when he said on a podcast that there was a reluctance in Britain to accept that “we’re all worse off, we all have to take our share,” and that workers and companies needed to stop passing price rises on to each other. Addressing the backlash, Pill said that he would “probably use somewhat different words,” but he continued to explain that having to pay more for what the UK is buying from the rest of the world relative to what it’s selling to the world is a squeeze on spending power.