The Bank of England today updated its medium term guidance for the UK economy and declared that inflation could fall below 1%. As such, it expects to keep interest rates at 0.5% for a good while yet, with wage rises also set to increase to 2% by the end of next year. If these forecasts are correct, it would represent the start of a period of real wage growth for the first time in around five years.
Increased Consumer Spending
Of course, real terms rises in wages could prove to be fantastic news for companies operating in the UK. Over the last five years, consumer spending has been pegged back somewhat by disposable incomes becoming smaller in real terms, and so a reversal in this trend could be great news for a range of consumer goods companies and retailers across the UK.
Even the psychology of being better off among shoppers could prove enough to make a real difference to the UK economy. Thats the case even if wage rises are set to be just 1% higher than inflation, according to the Bank of England. In turn, a more prosperous UK economy could lead to a higher FTSE 100index level and more demand for UK shares.
However, its the banks view on inflation that could prove to be the major catalyst for the FTSE 100 in 2015 and beyond. Thats because the Bank of England has very little scope to increase interest rates while inflation is so low, with a combination of low food and energy prices set to push inflation below 1%. As such, low interest rates look set to stay in place over the medium term and this is likely to be beneficial to the FTSE 100, since low interest rates encourage investment and risk-taking activities.
Of course, more QE is not off the table. With Europe beginning the process of its own asset repurchase programme as it gets perilously close to deflation, a UK inflation rate of less than 1% could cause the Bank of England to attempt to stave off price falls via more asset repurchases. Clearly, this would be excellent news for the FTSE 100 and would help to push asset prices higher; as has been the case over the last few years.
So, with the UK economy performing well, inflation and interest rates set to stay low over the medium term, and wages forecast to rise in real terms next year, the FTSE 100 looks to be well placed to deliver capital gains moving forward. Although 2014 has been a disappointing year thus far, with the FTSE 100 being down 2% year-to-date, the future could be much, much better for the UKs leading share index.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.