Is a pay boom coming and if not, why not?

Rarely has the trope that a week is a long time in politics rung truer. But yesterday we learned that an hour is a long time in economics.

The latest employment statistics are unambiguously encouraging. Employment rose and unemployment fell, strengthening trends in place over the past couple of years. Perhaps more significantly, rising nominal pay and zero inflation pushed real wage growth to its highest level since late 2007, driven by the private sector and the financial, retail and hospitality industries in particular. For a brief moment, it felt like the pay boom we’ve been waiting so long for may finally have arrived.

Not so fast. An hour later, the Bank of England’s quarterly Inflation Report gave the opposite message, downgrading nominal pay forecasts and increasing inflation expectations very slightly. As a result its real wage growth projection for the end of 2015 has fallen from 3 per cent (above the pre-crisis trend rate of 2 per cent) to 1.9 per cent (very slightly below trend).

Many, including the Resolution Foundation, thought the Bank’s previous forecast overly optimistic, so some downward revision might have been expected. But the new outlook implies that any above-trend rebound in wages will have petered out by the end of this year. Understanding what’s prompted the Bank’s newfound caution provides a good sense of the obstacles in the way of our nascent wages boom.

First is the question of the amount of spare capacity in the labour market. The Bank’s latest judgement is that there has been some slight narrowing of slack which should put pressure on wages, although it has warned that it may take “longer than usual” this time around. Add the prospect that wages may now be less sensitive to a given level of slack, an idea already tested by others, and the idea that recent absorption of spare capacity will be enough to fuel the fires of wage recovery looks increasingly tentative.

Second, low inflation, while helping real pay growth in the here-and-now, might ultimately prove self-defeating. The Bank raises concerns that today’s ultra-low inflation rate might weigh down on wage-setting decisions by firms, or leave workers satisfied with smaller pay increases. A full-blown deflationary spiral remains unlikely, but these judgements highlight the fact that inflation really can’t do any more of the heavy lifting than it’s already done in terms of boosting pay.

Third, changes in the make-up of the workforce, in particular a shift towards lower-paying jobs and staff who are new to their roles, might continue to hold back average earnings growth. Such factors caused a significant drag effect last year. The Bank now suggests this drag might persist longer than previously thought.

This final point gets to the heart of the issue. The Bank argues that this change in the make-up of the workforce also helps to explain the disappointing performance of productivity. In presenting a gloomier outlook on this front for this year and next, the Bank appears to be ruling out any near-term bounce. Long after inflation has started moving back towards more normal territory, it is productivity growth that will determine the extent to which economic recovery feeds through to pay packets.

The good news is that average earnings growth will likely continue to build in the near-term. The less good news is that, if we are truly to enter a period of strong, sustained wage growth over the medium term then the new government needs to put some serious effort into solving our persistent productivity puzzle. And that is a debate that has barely begun.

This post originally appeared on the guardian economics blog.