Evidence of and expectations for a sustainable firming in domestic cost pressures; and  3. Developments in core inflation consistent with a reasonable expectation that total CPI inflation will return to the target in around two years’ time. Progress in all three, both realised and prospective, will increase confidence that the initiation of limited and gradual rate increases will be consistent with returning inflation sustainably to the target. In this light, let me turn to recent developments. Momentum and slack After gaining momentum in 2013 and peaking around 3% in 2014, output growth has been steady during 2015, at rates close to 2%, a little below pre-crisis norms (Chart 5).11 The average quarterly growth rate for 2015 of around 0.5% has disappointed compared to the MPC’s summer expectations of 0.7%. This shortfall reflects much weaker net trade, the absence of a rebound in housing activity, and less robust consumption growth. Nonetheless, private domestic demand is still solid, and household consumption has been resilient. Consumption growth accelerated to 3% in the third quarter of 2015 (Chart 6), underpinned by the strongest real income growth since the crisis and highest consumer confidence in a decade. Excluding the understandable weakness in North Sea oil, business investment grew strongly throughout 2015. Surveys suggest investment intentions remain robust and, consistent with a stronger banking system, accommodative monetary policy, and very supportive credit conditions. Such solid private domestic demand growth can be expected to continue. 10  See Carney (2015a).

15  This is the simple economics behind the Wage Philips Curve. Phillips (1958). For a modern interpretation see Gali (2011). 16  These effects likely dragged on pay growth by around 1 percentage point last autumn. The implications of this for inflation are limited: because these workers also have lower average productivity, the net effect on firms’ unit costs is likely to be broadly neutral. BIS central bankers’ speeches  13  A final possibility is that the moderation in wage growth reflects the low headline inflation rate. With widespread recognition that there is literally no inflation at present, bargaining over real pay is more straightforward. Indeed, there is some anecdotal evidence from the Bank’s Agents that slower increases in households’ living costs have been a significant driver of lower pay awards. A simple estimated Wage Phillips Curve suggests a similar conclusion.17 If this is occurring, this will slow the build-up of cost pressures. The MPC must remain vigilant for signs that low inflation is having second-round effects in the wage bargain, possibly via inflation expectations. The mechanical return to higher rates of inflation as past falls in energy prices begin to drop from the annual comparison should in time reverse this effect and support wage gains. More fundamentally, falling joblessness and a high ratio of vacancies to unemployment should support wage growth. At a minimum, such dynamics suggest the need to continue to eliminate slack smartly. Of course, what matters for inflation is not wage growth in isolation, but pay relative to productivity.