Bank of England Governor Mark Carney managed to suppress hawkish dissent at the August MPC meeting but the latest Inflation Report forecast creates a strong presumption in favour of an interest rate rise before year-end.

It was always unlikely that more than one or two mavericks would defy Governor Carney’s recent signal that it would be premature to act before “the turn of the year” by voting for a hike in August. The silent hawks got their revenge by pushing through a rise in the inflation forecast two to three years out, putting them in a solid position to carry the day in November, barring downside data surprises or adverse financial market developments.

The best summary measure of the MPC’s collective view is the mean forecast for inflation in two years’ time based on unchanged policy. This was raised sharply from 2.35% in May to 2.60% in August. The 0.6 percentage point overshoot relative to the target is the largest positive deviation in the MPC’s 18-year history and sends a clear signal that rates need to start rising soon if the path back to neutral is to be “gentle”, as Governor Carney has promised.

Sterling initially fell on today’s news, with the market giving more weight to the 8-1 August vote than the hawkish forecast – wrongly, on the assessment here.

(A monetarist gripe: The structure of the Inflation Report has been changed, with a previous chapter on “Money and asset prices” replaced with “Global economic and financial developments”. There is no reference to money anywhere in the book – striking even by the Bank’s standards.)

A post in February suggested that deflation worries were overblown and that “core” consumer price inflation would remain stable in 2015. Recent news has played to this script.

Core CPI inflation, indeed, has risen slightly since the start of the year in the US, Japan, the Eurozone and China – see first chart. The main exception to the trend has been the UK, where a 10% increase in sterling’s effective index since end-2013 has acted as a significant dampener.

US core CPI inflation is under upward pressure from rising growth of housing rents – see yesterday’s post. Weakness in goods prices, meanwhile, may abate: producer price inflation of core consumer goods is well above the corresponding CPI rate and has moved higher recently – second chart.

Japanese core CPI inflation is underpinned by rising pay growth: the annual increase in scheduled wages climbed further in June, with a change in the timing of bonus payments explaining a fall in total pay – third chart.

The uptick in core CPI inflation in China contrasts with continued weakness in producer prices, suggesting that the latter reflects commodity price falls, a rising exchange rate and the economy rebalancing away from heavy industry, rather than significantly restrictive monetary conditions.

Bond market inflation expectations collapsed in tandem with commodity prices in late 2014 as the deflation scare took hold. The recent response to further commodity price weakness has been much smaller, suggesting market recognition of core inflation resilience – fourth chart.

Friday’s news of a smaller-than-expected rise in the employment cost index (ECI) in the second quarter has cast doubt on the prospect of an early Fed rate move. Annual growth in the ECI wages and salaries component fell from 2.6% to 2.1%, exactly reversing a first-quarter increase, despite evidence from job openings and other indicators of a tight labour market – see first chart.

The details, however, reveal that the decline was entirely due to a fall in wage growth in incentive-paid service occupations, following a sharp rise in the first quarter. Excluding all incentive-paid occupations, the annual ECI wage increase was stable, at 2.0%. In goods-producing industries, annual growth including incentive pay rose to 2.4%, a seven-year high  – second chart.

The volatility of incentive pay suggests averaging the first and second quarter results. Annual growth of total pay was 2.3% in the first half, up from 2.1% in the second half of 2014.

The second-quarter setback, therefore, is unlikely to be a deal-breaker for a September Fed move, although this will require further solid payrolls growth in July / August and other evidence that recent faster GDP expansion is being sustained.

In other inflation-related news last week, the housing rental vacancy rate fell to its lowest level since 1985 last quarter, suggesting a further pick-up in rental growth – third chart. Actual and imputed rents account for a combined 40% of the core CPI basket (i.e. excluding food and energy).