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Higher UK wages will be key to determining the extent to which the Bank of England is willing to tolerate an overshoot of its inflation target, according to governor Mark Carney.
Addressing MPs on Tuesday, Mr Carney said evidence of “second round” inflation effects, where higher prices push up wages, would move policymakers “close” to their limits on above target inflation.
“If [inflation] starts to influence wage behaviour and other price behaviour, and we start to see domestically generated consequences [for inflation] that moves us closer to the limit”, said Mr Carney.
UK inflation is expected to hit the BoE’s 2 per cent target this month on the back of a weak exchange rate and higher energy prices. The BoE has said however it is currently “neutral” on whether its next move will be to cut or raise interest rates from record lows of 0.25 per cent.
The BoE has been juggling a trade-off between an expected slow down in growth and an overshoot of its inflation target following the Brexit vote – with price growth forecast to hit 2.4 per cent by the end of 2019.
Latest figures show wage growth moderated at the end of last year, to 2.6 per cent from 2.7 per cent in the fourth quarter.
Mr Carney added the inflation uptick expected by the BoE was caused “entirely” by a weak exchange rate following the Brexit vote.
Chart via Bloomberg