The Bank of England yesterday issued a stark warning it would raise interest rate if workers won inflation-busting pay rises to offset the surge in energy costs.
Mervyn King, the Bank's Governor, told MPs the Monetary Policy Committee would monitor both wage levels and oil and gas prices over the coming months.
His warning came a day after Gordon Brown, the Chancellor of the Exchequer, wrote to public sector pay review bodies urging them to anchor any deals around the official 2 per cent pay target.
Mr King told the cross-party Treasury Select Committee: "We're going through a pay round in the next few months [and] it's very important that wage rises don't pick up to compensate for the rise in inflation."
He said the MPC had so far "drawn great comfort" from the fact it had not seen any so-called second round effects from the rise in oil prices. "It is important that there should not be second round effects as that would help to push up inflation relative to our projections, which have not included second round effects," he said. "Other things being equal that would make it more likely that policy would be tightened - higher interest rates - and that could mean unemployment would rise."
But he denied a suggestion by Labour MP Jim Cousins he was running an "incomes policy". "We will set rates according to the outlook for inflation - and one contribution to the outlook is what is happening to wages," he said.
On Wednesday the Chancellor wrote to the Pay Review Bodies warning them to stick to the 2 per cent figure or "risk converting a temporary increase in inflation into a permanent increase".
Asked whether he found the Chancellor's intervention "helpful", Mr King said: "He is certainly right to draw attention to the need in both public and private sectors for earnings growth not to try to compensate for that part of the pick-up in inflation that corresponds to higher energy prices."
The testimony by Mr King and four fellow MPC members - Kate Barker, Sir Andrew Large, Rachel Lomax, and David Walton - pointed to a consensus for keeping rates on hold.
Mr Walton, who voted for August's rate cut, said he now believed the risks were balanced rather than on the downside as he did in August. Ms Lomax said she was worried by the potential impact of oil prices in the supply capacity of the economy.Reuse content