Bank of England Policymaker Warns Strong Pay Growth Could Constrain Interest Rate Reductions
Megan Greene, a prominent member of the Bank of England's Monetary Policy Committee (MPC), has issued a significant warning that robust UK pay growth could substantially limit the scope for interest rate cuts throughout this year. In a detailed speech delivered at the Resolution Foundation thinktank in London, Greene expressed serious concerns that the apparent stabilisation of wage increases might hinder the ongoing battle against persistent inflation.
Wage Growth Concerns and Inflationary Pressures
Greene highlighted that the recent decline in wage growth "may have run its course", pointing directly to Bank of England surveys indicating that employers are planning to implement pay rises of 3.5% or more during the current year. This development comes despite the latest official figures showing that wage growth, excluding bonuses, experienced a slight moderation to 4.5% between September and November, down from 4.6% in the preceding three-month period.
The MPC maintains a strict inflation target of 2%, but recent data revealed that inflation climbed to 3.4% in December, marking an increase from 3.2% in November. Greene emphasised that consistent wage growth typically exerts upward pressure on inflation when not accompanied by corresponding productivity improvements. She expressed particular scepticism about any meaningful productivity rebound occurring this year, stating she was "certainly sceptical" about such prospects.
International Factors and Federal Reserve Influence
Greene further explained that the MPC's decisions regarding future borrowing cost reductions would be significantly influenced by the actions of the US Federal Reserve. Should the Fed implement more aggressive rate cuts than the Bank of England this year, this could stimulate US demand for UK exports, consequently creating additional upward pressure on UK inflation.
"If the Fed were to cut rates more aggressively than the Bank this year, this should cause US demand for UK exports to rebound, providing upward pressure on UK inflation," Greene cautioned during her address.
Bank of England's Forecasting Challenges and Labour Market Dynamics
Greene's warning coincides with the publication of a separate Bank of England report that acknowledged the institution had consistently underestimated the full inflationary effects following the 2022 energy price shock triggered by Russia's invasion of Ukraine. The central bank's inaugural forecast evaluation report revealed that "after 2022, the Bank's medium-term inflation and wage growth forecasts proved repeatedly too low."
The report identified that the Bank's economic models failed to anticipate how significantly higher inflation in 2022 would elevate household and business inflation expectations, leading to increased wage demands that subsequently fuelled further inflationary pressures. The Bank has committed to enhancing its "modelling and understanding of key economic mechanisms, including the labour market, wage-price interactions and inflation expectations" to better comprehend recent patterns of inflation persistence.
Business Survey Findings and Economic Implications
A closely monitored purchasing managers' index from S&P Global revealed that UK businesses reported a sharp increase in costs during January, with the overall inflation pace remaining unchanged from December's seven-month high. The survey indicated that companies across manufacturing and services sectors were "overwhelmingly" attributing rising costs to "elevated wage pressures", alongside increased transport expenses and higher raw material prices from suppliers.
These mounting cost pressures prompted firms to implement the most significant price increases to their own products and services in over a year. The survey also documented a "steep loss" of employment among many respondents, particularly within the hospitality sector, with numerous companies blaming job cuts on the government's introduction of higher national insurance contributions and increases to the national living wage.
Market Expectations and Economic Outlook
The survey findings have prompted City economists to revise their expectations regarding MPC interest rate decisions, with predictions of two rate cuts this year being reduced and the first quarter-point reduction now anticipated no earlier than June. The current base rate stands at 3.75%, following four cuts implemented by the MPC during 2025.
Despite these concerns, the purchasing managers' index showed a reading of 53.9 in January, representing an increase from 51.4 in December and reaching a 21-month high. Any score exceeding 50 indicates economic expansion, suggesting some underlying resilience within the UK business sector despite the prevailing inflationary challenges and wage pressures identified by policymakers.
