The danger that wage bargainers could win big pay increases this winter to recoup the cost of rocketing gas and electricity bills as well as this year's jump in petrol prices was highlighted yesterday by Bank of England governor Mervyn King.
Following up Chancellor Brown's warning on Monday that he intends to "discipline" public sector pay, Mr King told the Commons Treasury committee that big increases in either the private or the public sector could drag inflation away from the Bank's two per cent target.
He stopped short of saying that the Bank would respond by raising interest rates, but the implication was clear.
People negotiating pay should resist attempts to try to compensate for higher energy costs with increased salaries, Mr King said.
"We will set interest rates on the basis of the outlook for inflation. It is important that there are not second-round earnings effects which would push up inflation.
"Our concern is what comes out of the wage-negotiation process. Those people who enter into wage bargaining agreements should take into account our intention to keep inflation close to two per cent."
Asked outright by Labour MP for Newcastle Central Jim Cousins whether wage increases could lead to an increase in interest rates, Mr King turned non-committal.
"If there were to be further increases in average earnings growth, that would be one of the factors that we would look at," he said. But it was "too early to be sure that the pickup in inflation would lead to increases in pay".
The Bank's interest-setting Monetary Policy Committee would continue to monitor pay and inflation before making any decisions on the future direction of interest rates.
The meeting followed the publication of the Bank's quarterly Inflation Report last week, which said that inflation should fall below two per cent next year as this year's steep rise in the price of oil fell
out of the 12-monthly equation.
Mr King told the MPs: "The central projection remains close to the target of two per cent over the next two years."
He struck an optimistic note about prospects for the economy. Although there had been a slowdown at the end of last year and in the first half of 2005, this was now being reversed. The Bank expects the economy would quicken next year helped by the failure of the widely feared crash in house prices to materialise, which should boost consumer confidence. The growing consensus that the Bank's official interest rate will stay at 4.5 per cent for some time was reinforced by comments from Kate Barker, one of the MPC members who voted against Mr King for a quarter-point cut in August.
"It was not necessarily to be seen as the start of a run of cuts," she told the MPs.
A new member of the committee, David Walton, pointed out that expectations have changed since August.
"If you had asked us then if rates would be at four per cent by the beginning of next year, I think you would have found a unanimous agreement."
Mr King also suggested that a gas shortage causing industrial cutbacks could have wider economic consequences.
"There might be some risk to economic activity over the the next year if there were to be reductions in supply because of the effect of higher energy prices," he said. But there was no certainty that such a situation would arise.
