Governor calls for wage restraint to avert rate rises

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The Governor of the Bank of England, Mervyn King, called for restraint from wage-bargainers last night, warning inflation-busting pay settlements could trigger further rises in interest rates.

In a keynote speech to the Birmingham Chamber of Commerce annual banquet, Mr King stressed the importance of the January pay round in bringing inflation, currently running at 3 per cent, back to its 2 per cent target. "All of us - whether on the shopfloor, in the boardroom, or in the public sector - are coming to terms with the fact that higher costs imply a temporary, but only a temporary, slowing in the growth of our real take-home pay," he said. "That adjustment - difficult but inevitable - will be helped by the fall in energy prices since last autumn.

"But the belief that we could avoid the adjustment by pushing up our pay would lead to a self-defeating process of higher wages offset by higher prices. It is the task of the MPC [Monetary Policy Committee] to ensure that the process of adjustment does not lead to a persistent rise in inflation."

The Bank has become increasingly concerned that the recent surge in RPI inflation - traditionally used in pay bargaining and currently at a 15-year high of 4.4 per cent - will encourage inflationary pay settlements and set in train a wage-price spiral. Those fears already look justified - a report last week from Industrial Relations Services, the pay consultants, revealed the average pay deal in January so far is 3.6 per cent, up sharply from 3 per cent in December.

Mr King also used the speech to defend this month's rate rise, by a quarter-point to 5.25 per cent. He said that by acting sooner rather than later, rates would need to be raised by less, adding that it was the timing of the move, rather than the move itself, which had caught the City on the hop. The MPC's view remained that inflation was likely to fall back in the second half of the year, possibly quite sharply, he said.

The comments came as the pound surged to within touching distance of $2, amid fresh signs that inflationary pressures are building, this time within the manufacturing sector. Extending a rally that has seen it gain more than six cents in the past two weeks, sterling hit a 14-year peak of $1.9916, its highest since it was ejected from the European exchange rate mechanism in 1992.

Analysts said expectations of higher interest rates were boosting the pound, with foreign investors piling into sterling assets in the hunt for yield. Past assaults on $2 have seen sterling beat a hasty retreat, but experts said the move could be more sustainable this time.

Yesterday's leg-up followed a report which showed that manufacturers are raising prices at the fastest rate for nearly 12 years to try to rebuild crumbling profit margins. The CBI Industrial Trends Survey revealed that a net 15 per cent of manufacturers have pushed through price rises in the past three months, up from 3 per cent in October and the highest balance since July 1995. News that they intend to continue raising prices added to the view that the MPC faces a prolonged battle against inflation.