The Bank of England says a rate hike is not likely until 2016; the markets are pricing in a 2015 hike. But might they rise even sooner than that?
These days it’s about unemployment. The Bank of England now says that for as long unemployment is above 7.0 per cent it won’t be upping rates. It says this is not likely to happen until 2016, that the markets are too optimistic, and that there is just a one in three chance of a rate hike sooner than that.
One of the lessons of the last few years is that when the economy is entering a downturn, economists and markets alike tend to underestimate the speed of contraction. Yet it seems equally clear that when things are improving, markets and economists tend to underestimate the speed of recovery.
The OECD has joined a long list of economic forecasters to revise its projections for UK growth upwards. The latest Purchasing Managers’ Indices (PMIs) from Markit/CIPS point to quarter on quarter growth of between 1 and 1.34 per cent in Q3. In fact, the latest composite PMI tracking construction, services and manufacturing has hit its highest level ever since records began in the late 1990s.
So if the UK economy is expanding so much faster than the wildest optimists forecast just a few months ago, is it not possible that UK unemployment will be back to 7 per cent faster than both the Bank of England and markets are predicting?
Yet more evidence to support this case comes from recent data from the ONS. It has recently begun experiments with month on month data on UK unemployment and recorded a fall from 7.8 to 7.4 per cent in July. A recent survey from the CIPD has its headline index tracking employers’ intentions to hire more staff hitting its highest level since 2008. The PMIs for July pointed to the fastest rate of job creation since 2007. And if we really do see the boom in residential construction that many are predicting, the effect on employment will surely be significant.
There are problems with these rosy forecasts, however.
For one thing, data on month on month changes in the jobs markets are highly volatile – the August data may see July improvement cancelled out. The PMI for August may have pointed to faster growth, but as far as job creation is concerned, it was nowhere near as positive as the July reading.
The big doubt related to what they call the productivity puzzle.
Until recently a characteristic of the UK economy has been disappointing growth in GDP, but surprisingly robust jobs figures given the state of the economy. Of course the mathematics of poor growth but reasonable job creation has meant poor productivity. Lots of theories abound for the poor growth in productivity, with one of the most popular being that employers have been choosing labour which has low upfront costs, over investment into capital equipment. In other words, they prefer staff, who they can always fire, to labour efficient machinery which requires a bit of upfront outlay, and cannot not be easily sold. Is it not possible that as the economy improves, so will productivity, and just as unemployment was relatively low in the recession, it will be relatively high in the recovery? If that is right, then interest rates may stay at half a per cent for some time yet – regardless of whether the recovery exceeds expectations.
© Investment & Business News 2013