Wednesday 13 August 2014

‘Paymageddon’ shows it’s not yet time for higher interest rates

The Office for National Statistics (ONS) this morning released the latest set of UK labour market data, mostly covering the three months April to June 2014, while the Bank of England has also published its latest quarterly Inflation Report.

The ONS figures reinforce the conclusion that the ongoing labour market recovery will serve to re-write the economic textbook: a record number of people in work (up 167,000 in the latest quarter, mostly due to more full-time employees, to a total of 30.56 million) unemployment falling at an even faster pace of decline (down 132,000 to just over 2 million, a rate of 6.4%), yet all this combined with ever lower pay pressure (average weekly earnings including bonuses shrinking by 0.2% in the year to June). In other words the jobs data indicate a boom but a fall in the cash value of total average weekly earnings signal ‘Paymageddon’.  

What’s good news for the jobless is thus being offset by ever slimmer pickings for those already in work, giving the UK labour market a distinctly bitter-sweet flavour. No wonder then that Bank of England Governor Mark Carney, in his remarks at the Inflation Report press conference, commented at length on the consequences of what he and other members of the Monetary Policy Committee conclude has been a ‘labour supply shock’ to the UK economy.

Carney’s comments, which broadly reflect my own analytical perspective, is that a structural increase in the supply of people active in the labour market has dampened underlying wage pressure. This will in turn eventually enable the economy to sustain a higher rate of employment and lower rate of unemployment than was attainable prior to the recession but in the interim an abundance of relatively cheap labour has caused the UK to become a more labour intensive, low productivity economy. However, while this is currently very painful to people in work, at some point the large amount of slack currently still available in the labour market will be absorbed, putting upward pressure on pay and pushing businesses to raise productivity in order to counter rising unit wage costs.

What nobody knows, the Bank included, is precisely how long this process will take and thus also at which point stronger pay pressure might warrant a rise in interest rates since this will also be affected by what happens to productivity. The Bank’s position is that it bases its judgement on interest rate decisions on an assessment of the trend in all the available data, which obviously keeps us guessing. But judging by the latest ONS data the UK labour market doesn’t look as though it needs an interest rate rise to cool things down but, on the contrary, further strong sustained expansion to help workers desperate for a pay rise.

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