Tight labour market should not make Bank of England raise rates automatically says MPC economist

Jasper Jolly
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The UK has tightest labour market since before the financial crisis (Source: Getty)

A tightening labour market should not necessarily prompt the Bank of England (BoE) to raise interest rates, according to a member of the Bank’s rate-setting body.

“Monetary policy should not be set in a way that seeks to rule out sub-5% unemployment over time,” Michael Saunders, an external member of the Bank’s Monetary Policy Committee (MPC), was expected to say. He made the comments in a speech at the Resolution Foundation think tank.

Saunders also stuck to the Bank’s neutral stance on future monetary policy movements in the face of inflation above the Bank’s two per cent target and “stronger than expected” growth to come next year.

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Saunders said the labour market is “very tight”, with 4.8 per cent unemployment at a level rarely seen in the past 40 years, but that it was unlikely to rise markedly in the coming year.

"Rather than the rise in unemployment forecast in the November Inflation Report, it seems quite possible to me that the jobless rate will stay below 5 per cent this year," he said.

The Bank of England cut interest rates to 0.25 per cent after the EU referendum result, when political chaos and a plunging pound threatened a severe hit to economic growth. The Bank's forecasts show inflation rising sharply in 2017, and a rise in the unemployment rate – although immediate forecasts of economic slowdown have been proven wrong.

Saunders also joined his MPC colleague Andy Haldane, the Bank’s chief economist, in highlighting the failure of forecasters – what Haldane called a "Michael Fish" moment – as the UK has undershot OECD forecasts more than any other country.

“Labour market forecasters have “not done well in explaining and forecasting the modest trend in pay growth,” he said.

The persistent forecasting errors could point to a new era of wage growth, according to Saunders.

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“Pay growth will probably stay comfortably below the 4% pre-crisis norm during the next few years,” he said. “Expansion of contingent work probably also reflects the erosion of secure and well-paid jobs from technological gains and greater emphasis on cost control.”

Meanwhile the UK remains an attractive market for migration, says Saunders, despite the recent fall in the value of sterling. He also notes regions with high migration levels have seen the highest undershoot in expected wage growth.

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