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BoE eyes wage growth in rate hike riddle

Stefan Rousseau | WPA Pool | Getty Images

Right next to the meeting room where the Monetary Policy Committee is sitting today, is the Bank of England's famous Court Room. Near the ceiling is a dial, connected to a weather vane on the roof.

That weather vane was Britain's original economic indicator. When it was blowing from the east, Bank officials would know ships would soon be sailing up the Thames to unload their wares and traders would soon be drawing down money to pay for the goods.

The Bank would fetch the cash from the vaults to make sure everything ran smoothly.

Today, policy is a little more complicated. The Bank has other indicators to follow. Chief among them for the current batch of rate-setters is wages and unemployment.

Read MoreECB 'won't move a muscle' despite inflation fears

Markets reckon the first rise in interest rates could come before the end of the year. Whether they are right, will depend to a large degree on wages.

The Bank is acutely concerned about household debt levels. Should costs rise, for petrol or energy bills, for example, household finances would be squeezed further. A rise in interest rates to combat such inflationary forces would only squeeze incomes more and starve the economy of demand.

For that reason, the Bank has signaled it will "look through" one-off spikes in inflation, even those caused by the strong pound. All those policymakers today care about is whether wage inflation is pushing upward pressure on prices. It's then that they will feel obliged to raise rates, and confident that households could withstand the increase in borrowing costs.

For the time being, the threat appears to be non-existent. Regular pay rose just 0.7 percent, according to the most recent official data, the lowest rate since records began in 2001.

Read MoreClothes lead UK's record shop price plunge

That follows an 8 percent collapse in real wages between 2009 and 2013, deeper than the 1970s or the post war austerity.

The Bank's monthly agents report and other surveys suggest that pay inflation is building. The question is when that will start feeding through to the consumer prices index that the Bank is supposed to keep around 2 percent. Currently, the CPI is just 1.9 percent.

Of course, house prices are rocketing upwards - at 10.2 percent in July from a year earlier according to lender Halifax on Wednesday. But the Bank has said rate rises are only the last line of defense against a property bubble.

The economy is motoring on. Growth is running at an annualized rate of 3 percent, the highest since 2007 and unemployment may drop below 6 percent before the year is out.

Now the economy has reached "escape velocity", to coin Mark Carney's term, the only thing holding the MPC back from raising rates is any sign of healthy wage growth. At the first sign that is back, rates will start to increase, It won't be today, though.

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