The key is the productivity bit. Consider a worker flipping clay onto a mould to make plates; you can enhance productivity by getting him to work longer or you can invest in a machine to flip the clay on to the moulds. That way the worker can supervise several machines flipping clay and he becomes more productive and can get paid much more.

Businesses are always faced with a choice of hiring more workers or investing in machines to automate the process. The tipping point is thought to be a shortage of supply in the workforce which creates the prospect of wage inflation which in turn stimulates investment as opposed to new, more expensive hires. The big question that we are all trying to answer is, “what level of unemployment do we need before we get wage inflation?” The thinking is that it is different now as there are more workers available this time around.

The cohort aged 55 to 65 must be looking at the dismal performance of their pensions over the last 15 years and deciding to work for longer to boost their retirement pots and income. In addition, they must also be thinking that they are going to live for longer, and therefore will need a greater fund to see out their retirement. Again, they will need to work for longer. Personally, I have seen parents decide to work for longer to help their children get on the property ladder. So, we conclude that there is a greater availability-for-work of the pre- and post-retirement age demographic than there has been in previous recoveries.

This delays the point where wage inflation kicks in and with it the day that companies start investing heavily in capital expenditure (capex) to boost productivity. Also weighing on the decision of companies to (a) invest or (b) hire more workers is the fear of what’s around the corner.

It is quite easy to reverse out of a hire if you go into a down-turn. But you can’t really reverse out of capex on a new industrial plant for example. So companies need to be confident before they invest in capex. Sadly the Labour party’s attacks on business, the prospects of the Scottish referendum, business-destroying Russian sanctions and the worry that surrounds potential interest rate rises is not conducive for confidence.

Interest rates are a double edged sword; there is a theory that there are zombie “living dead” companies who are using up capital and blocking entrepreneurs from entering markets due to the low interest rate policy. Higher interest rates would put them out of business and create opportunity for entrepreneurs. But the downside of higher interest rates is the extent to which consumers could cope with higher borrowing costs.

Companies can also allocate their cashflows to cashbacks, mergers & acquisitions or de-leveraging rather than capex or more employment.

We think that Mark Carney’s lack of consistency in interest rate guidance is a mixture of an attempt to measure how the market reacts to threats of (a) higher rates sooner and (b) lower rates for longer as well as an attempt to create interest rate volati lity. Carney is probably trying to stop low interest rates driving excessive asset and house price inflation by prompting people to question the status quo.

Our conclusion is that wage inflation is further away than people think because more of the 55 to 70 year old cohort is prepared to work for longer than in the past. We also think that companies are probably more worried than people think as well.

This leads us down the lower interest rates for longer path of thinking, which also ends in higher inflation than people currently expect as well.

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