Sunday, March 25, 2018
A green light for the Bank to keep on raising rates
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.

It is reassuring, for those of us who write about economics, when things happen the way that economic theory says they should. When unemployment is low, pay pressure should increase, and it is finally happening.

Though the latest official figures were not as clean as might have been hoped – the number of people unemployed rose by a tiny 24,000 in the latest three months though the unemployment rate fell from 4.4% to 4.3% - they were accompanied by an acceleration in earnings growth.

The Phillips curve, the inverse relationship between unemployment and wage growth, is one of the first thing students of economics learn. Earnings growth excluding bonuses picked up to 2.6% and to 2.8% including them. Inflation, though for a little later than the November-January period to which those figures apply, is now 2.7%.

Behind these bald comparisons, and the welcome news that the Phillips curve is alive and well, though not necessarily for employers facing higher wage bills, there are quite a few implications. Let me take just two of them.

The first is whether the end of the wage squeeze, and the return of modest pay growth, will do anything for attitudes towards a job market which has been extraordinarily successful in generating unemployment but is still widely regarded as insecure and exploitative. The second is whether anything will stop the Bank of England raising interest rates in May, and again later in the year.

Britain’s flexible labour market continues to generate jobs at a significant rate, as it has done for several years. In the latest three months employment increased by 168,000, while over 12 months there has been an increase of 402,000.

There is a downside to this in the sense that rising employment alongside weaker economic growth means stagnant productivity, and the latest figures for hours worked suggest that that the pick-up in output per hour in the second half of last year was indeed a blip.

Overall, however, this is a picture of success. Some of the rise in employment has been achieved by bringing people out of economic inactivity, when they are not working or seeking work. The rate of inactivity among working-age people, 21.2%, is at its joint lowest since records began in 1971.

Digging into the employment numbers, one of the things often associated with insecurity is the rise in self-employment, which includes gig economy workers. Self-employment is, however, now falling, both in absolute terms, to below 4.8m, and as a proportion of overall employment. In contrast, the number of traditional full-time employee jobs is rising strongly; up 377,000 over the latest 12 months.

The labour market, then, is continuing on the path it has been on since the crisis. Though public sector employment, when adjusted for reclassifications, is rising again, it remains the case that the private sector has created roughly seven times the jobs lost as a result of austerity in the public sector.

Perhaps attitudes will change when real wages pick up a bit, though one likely effect of lower inflation is that employers will seek to scale back pay awards. Maybe people are programmed to be curmudgeonly about the job market, something that was noticeable when employment was booming, and real wages rising strongly, in the 2000s. The symptoms are an over-emphasis on zero-hours contracts, covering fewer than 3% of people in work, and nostalgia for a past that never really existed. Will this change? Maybe not, but we shall see.

On my second question, on interest rates, a rise in May looks pretty much baked in, following the stronger wage figures and the agreement on transition between Britain and the EU. Two members of the Bank’s monetary policy committee (MPC), voted for a hike in last week. On Friday another member, Gertjan Vlieghe, said people should expect one or two rate rises a year for the next trhee years. All members endorsed “an ongoing tightening of monetary policy”. The Bank is prepared for the first quarter gross domestic product figures to be adversely affected by the Beast from the East and its successor, but intimated that this will not deter it.

A rate rise in May, to 0.75%, would in many respects be more significant than the hike to 0.5% in November. That one was merely reversing the emergency cut after the Brexit referendum. This one would take us into new territory.

Assuming it happens, what about beyond May? The case for raising rates even against a weak growth backdrop is, for the Bank, quite straightforward. The economy’s “speed limit”, its underlying or trend growth rate, is now estimated to be a weak 1.5% a year. The Bank’s forecasts are for growth to be a little stronger than that, averaging 1.75% a year, increasing domestic inflationary pressures, which higher rates will help subdue.

What could get in the way of higher rates? One argument is that inflation, which is already below the Bank’s expectations, could fall further and faster from here than it is predicting. The Bank expects it to stay above the 2% target until 2021 on the basis of market interest rate assumptions.

A second argument is about growth. What if it is weaker than the Bank is predicting/ The Office for Budget Responsibility (OBR), for example, does not expect growth to exceed 1.5% between now and 2022, a strikingly weak prospect. Its forecasts for the next three years, 1.5%, 1.3% and 1.3%, would leave growth tucked in just below it and the Bank’s 1.5% speed limit.

There are risks to growth, in both directions, which do not have to be spelled out here. Simon Ward, chief economist at the fund managers Janus Henderson, a dedicated followed of money supply data, notes that the growth rates of narrow and broad money are at their weakest since 2012 and appear to be weakening further since the November rate hike. If the money supply slowdown signals slower growth ahead, then the Bank risks a policy mistake by raising rates, he argues.

It will be a surprise if the Bank does not raise interest rates in May; America’s Federal Reserve did so again, and without fuss, last Wednesday. But the path towards a new normal for Bank rate of 2% or so, on which it has embarked, is unlikely to be a smooth one.