Can wage inflation stay low if price inflation accelerates?
UK price inflation is heading back up again, yet the central bank has cut interest rates twice in three months. How can it justify this when its inflation target is 2% and the actual rate of inflation is above this level and likely to rise even further in the months ahead? The answer, of course, is that the central bank is looking for economic growth to slow such that inflation falls in the medium term. The Monetary Policy Committee (MPC) noted in the minutes of the February meeting that ‘the central projection suggested that there was most likely to be some spare capacity in the economy, even if interest rates followed the path implied by market yields. That would therefore help to ensure that inflation returned to the 2% target in the medium term’. This is illustrated in chart a, which assumed Bank rate would be cut to 4.5% in 2008 and stay there and that UK economic growth falls to well below 2% by the middle of 2008 before recovering back to trend in 2009. But the MPC was still ver
