Sunday, September 21, 2014
Weak pay and low inflation mean no rate hikes just yet
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

After all the excitement - and for me the right result - time to return to some normal but rather interesting fare. While we have been preoccupied with other things, there have been developments. The question is which way they are pointing.

On the face of it the job market continues to roar away. The unemployment rate, now just 6.2%, is at its lowest since October 2008 – just as the financial crisis was starting to do really serious damage – and is down from 7.7% a year ago.

Without rubbing salt into old wounds, a year ago the Bank of England though it would take until 2016 just to get down to 7%, let alone to be knocking on the door of 6%.

The fall in unemployment over the past year, the fastest for 25 years, takes the wider jobless total down to just above 2m (2.02m), while the narrower claimant count has dropped below the symbolically important 1m level; it is now 966,500.

Add the rise in employment, an extraordinary 774,000 over the past year, with a record 30.61m people in work, and a near-record 73% of the workforce, and it looks like a job market on steroids.

Nor is this without its wider economic effects. Another set of official numbers, for retail sales, showed that spending last month was an inflation-adjusted 3.9% up on a year earlier.

For those thinking we have an economy a little too strong for comfort, all this was ammunition. Martin Weale and Ian McCafferty, two members of the Bank of England’s monetary policy committee (MPC) voted for a second consecutive month for a hike in Bank rate.

They, according to the Bank’s minutes, think the economy is flying high on the stimulus of ultra-low interest rates and while policy remains so “expansionary” spare capacity will be used up, wage pressures will increase and inflation will rise. Modest rate rises now will help cut that danger off at the pass.

For all the strength of these numbers, however, there is another side to the story. Inflation, at 1.5%, is below target and still falling, according to new figures last week. The growth in average earnings has turned positive again, rising by 0.6% in the latest three months compared with a year earlier, or 0.7% for regular pay.

While the unemployment and retail sales numbers look very strong indeed on the surface, some other bits of evidence suggest an economy in which growth is moderating. The National Institute of Economic and Social Research estimates that growth in the June-August period was 0.6%, slower than its recent quarterly growth rate of 0.8%.

Even in the labour market figures, and even apart from the weak pay figures, there were one or two signs that things were not as strong as they have been. The latest three-monthly rise in employment, 74,000, was the smallest since the spring of last year. Though it is too soon to call a break in the trend, the number of people characterised as economically inactive rose by 114,000 in the latest three months, its biggest increase since late 2009/early 2010. It had been falling.

On the face of it too, the figures for pay are going nowhere. Manufacturing is the only significant sector of the economy in which pay in the latest three months outstripped inflation but not by much (2% versus 1.5%). One area where pay was doing well – the large wholesaling, retailing, hotels and restaurants sector – has seen pay growth slow to just 0.6%; in line with the national average increase. It could be that pay increases in this sector are being delayed until the minimum wage goes up from £6.31 to £6.50 an hour next month but it will be a long time until we see this in the figures.

Some of this weakness in pay is hard to square with on-the-ground experience. Last week I helped chair the Countryside/What House? new homes debate at Molineux, Wolverhampton, where the talk was of skill shortages driving pay higher, and materials shortages doing the same for other costs. It may be that we are seeing the first inklings of this in the numbers. For one month only, July, the official statistics showed construction pay up by a hefty 4% (by recent standards) on a year earlier. But again, too early to call a trend.

Similarly, there are the first stirrings of a revival in productivity in the fact that the rise in employment, and the total number of hours people are working, was smaller than the increase in economic output. But we need more data to be sure that faster productivity growth is finally kicking in.

So the economy is genuinely quite hard to read at the moment. Growth has been very strong, as has the job market, but both are showing tentative signs of softening. Inflation is below target, and likely to remain so. We may be looking at a low point of just above 1%, with no return to the 2% target for a long time.

As for pay, its weakness was a puzzle when the job market was so strong. It may become less of a puzzle if the growth in employment really is weakening.

What does this mean for interest rates? Though I have some sympathy for Weale and McCafferty on the MPC, and though they are correct to say that the MPC has to anticipate, not merely respond, I would not vote for a rate rise at the moment.

One reason is the uncertainties about the data, outlined above. The other is that the first hike in rates since 2007 (and the first move from 0.5% since March 2009) would have to be clearly explained to households and businesses.

Mark Carney had a go in his recent speech to the Trades Union Congress but more will need to be done. Raising rates for the reasons set out by the two hikers in the MPC minutes – the concern that spare capacity will be used up rapidly, generating inflationary pressures, does not quite do it.

It may be that come early next year, the evidence is coming through strongly on rising pay. And it may be that recent tentative evidence of slowing growth turns out to have been a false signal. Under those circumstances, a rate rise would be fully justified. Doing it now would look premature.