Link interest rate increase to wage growth says economic group

By Natasha Adamson

The Bank of England is being urged to add to it's forward guidance policy by linking any future increase in interest rates to growth in real-term wages.

The EY Item Club, an economic forecasting group, has produced a report which says the fragile recovery of the economy is at risk of being killed off if interest rates are increased too quickly. Mark Carney moved quickly to allay fears over interest rate increases when he became the Governor of the Bank of England last year. In linking an interest rate increase to a drop in the rate of unemployment to 7 per cent it was thought that a freeze was essentially guaranteed until 2016. However, a surge in growth in the UK economy has meant that the target 7 per cent rate of unemployment is likely to be reached before the half way point of this year.

As such, the EY Item Club is urging the Bank of England policy makers to add another element of forward guidance by linking an interest rate increase to a growth in real-term wages, which they say have only been growing at half the rate of inflation.

The increase in living costs is reducing many mortgage borrowers capacity to meet their current monthly mortgage payments, and a rates increase that comes ahead of a lift in wages would only further compound that difficulty. Other more fortunate home owners have been able to take advantage of the rate freeze to overpay on their monthly mortgage payments and increase their equity share in their home, and first time buyers have also benefited from the low rates to get their foot on the property ladder. Anyone in the process of switching their mortgage is also paying close attention to the developments in the economy, as they weigh up their options of a fixed or variable rate mortgage product.

While the unemployment target rate of 7 per cent is expected to be reached in the second quarter of this year, most economists have agreed that an interest rate increase is unlikely until 2015. Adding to the forward guidance policy would certainly bring more clarity to the future of interest rates for individuals and businesses alike, but for now there is a widely held view that the government is not in any rush to increase the rate until the economy is showing growth across all the major indicators.

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