Families should take advantage of the current period of falling petrol and food prices “while it lasts”, the Governor of the Bank of England has said, as he urged employers to ignore temporary low inflation and raise pay.
British households are on course to enjoy the biggest increase in their take-home pay in more than a decade, the Bank’s latest evaluation of the economy showed on Thursday, with real post-tax income expected to rise by 3.5pc this year.
This is more than double its estimate of 1.25pc just three months ago and would represent the biggest increase since 2001. The Bank also signalled that it was on course to raise interest rates next year, as it raised its growth projections and lowered unemployment forecasts.
In an interview with the Telegraph, Mark Carney said inflation was “more likely than not” to turn negative in the coming months, largely due to a dramatic fall in oil prices. He said the cost of living would rise just 0.5pc this year overall, the slowest pace since records for the consumer price index began in 1989.
Mr Carney said this was “unambiguously good” for economic growth as price falls – particularly in petrol and food – encourage families to buy more goods.
But he warned: “This is temporary. It’s an important point, two thirds of this…has been from falls in food and energy prices. Enjoy it while it lasts, because this will go away over the course of the next year.”
Mr Carney suggested that lower petrol prices, however, were here to stay, as the Opec oil producing cartel continued to pump oil into the market amid falling demand. He said: “A sharp retrenchment in supply, all things being equal, is less likely in the near term, which would limit the recovery in the oil price.”
The Governor said that the temporary nature of many price falls should not discourage businesses from sharing the benefits of Britain’s economic recovery with their employees.
Mr Carney said that while pay settlements should be driven by a “degree of competition” and the ability of businesses to generate profits rather than David Cameron’s plea for companies to hand Britain a pay rise, he also sent a clear message to companies that the Bank was on course to steer inflation back to its 2pc target in the next two to three years.
With 40pc of pay negotiations taking place in April, Mr Carney urged businesses to “embed” the idea that low inflation would be relatively short lived. The Bank believes strong employement growth and higher confidence among workers will encourage people look for new jobs and higher salaries.
“What should be embedded in the background of all those discussions is an expectation in all those discussions is an expectation that inflation is going to be at target , so that doesn’t enter into the wage bargaining or discussions,” he said.
Since the financial crisis, British workers’ wages have grown slower than the cost of living. However, the trend was reversed at the end of last year as inflation fell to a record low of 0.5 per cent.
The cost of living crisis was expected to be a major General Election issue, but recent figures have prompted the Conservatives to claim their economic plan a success.
However, the Governor warned that if inflation turned negative the Bank of England may have to temporarily cut interest rates – dealing a blow to savers.
While a number of central banks, including the European Central Bank (ECB) and Swedish central bank have cut rates in order to fight deflation, Mr Carney insisted the UK remained on a path of gradual and limited increases.
He said the Bank is not yet considering extra stimulus, but that it had “many options” for doing so in the event of prolonged low inflation.
“The risk though is that you go through a period of very low prices, say inflation around zero for the balance of the year, and that is principally driven by the big falls in petrol prices. That moves into inflation expectations. It influences wage settings, it broadens out to a range of other prices, and that imparts a persistence to low inflation.”
Markets currently believe interest rates will not reach 1.5 per cent until 2020. While Mr Carney did not validate the forecast, he said rates were “unlikely” to get back to historic levels of around 5 per cent “for some time”.
“You will likely have scenarios where the economy is operating at potential and inflation is at target and the appropriate level of bank rate to keep the economy there is much lower than it was previously,” he said.
Mr Carney said the biggest risk to the economy comes from overseas, and repeated calls that fiscal union is necessary.
“The most immediate risk comes from abroad, whether it’s geo-political, where there’s a fast moving set of circumstances as we sit down today, or these questions around the ability of Europe to move out of a period of stagnation to a higher level of growth,” he said, though he added the risk to the UK economy from a sudden Greek exit has receded since 2012 as British banks have better capital cushions and have reduced their exposure to the country.
He also said the eurozone would not be truly safe from future shocks until more risk sharing takes place.
“In order to have an effective currency union, you need a full range of private risk sharing such as a banking union, a capital markets union and you do need an element of public risk sharing and I think the experience here and experience across currency unions bears that out.”