IT’S official: even the Bank of England now agrees that the economy is recovering. It has hiked its growth forecast for this year and next (to 1.6 per cent and 2.8 per cent) and has been forced to concede that unemployment is falling far more quickly than it had been expecting.
In a drastic dilution of the assumptions surrounding its forward guidance, it now sees a 40 per cent chance that the unemployment rate – its crude proxy for spare capacity – will smash through its 7 per cent threshold by the end of next year. This is hugely important: the Bank has decided that hitting that threshold is a necessary but not sufficient condition for increasing its interest rates (ignoring a few caveats).
Sure, it still clings to the view that it will probably take until 2015 before unemployment actually falls to 7 per cent (it is currently at 7.6 per cent and dropping fast); but the details of the forecasts show a drastic change in thinking in just three months. It also means that rate hikes could now theoretically come before the general election, though some excuse or other will probably be found to keep them down.
That is a great shame: the Bank should already have started to gently and gradually hike rates by now, well before any over-heating, rather than be planning to wait until it’s too late. That is one of the most basic lessons of monetary policy. Economists used to grasp that there are long and variable lags between a tightening in monetary policy and its actual effect on the economy. Phased hikes would also remind borrowers to be careful; they would nip any irrational exuberance in the bud and make saving more attractive. Thankfully, the markets are doing their best to tighten policy themselves, disregarding the Bank’s guidance: sterling and market rates are rising.
I remain nervous about Britain’s medium term performance, the limited usable spare capacity in the economy, the accelerating rise in unsecured consumer credit (and with the mortgage market rebounding, the imminent rise of overall consumer credit as a share of GDP), our over-valued housing market and how borrowers will react if rates are hiked too quickly in 2015-16 as a result of today’s excessive dovishness.
But the short-term outlook is bullish, suggesting a stellar performance over at least the next couple of quarters.
Over the year to October 2013, the number of job seekers allowance claimants fell by 266,500, the largest annual drop since May 1998. The employment rate is up by 0.6 percentage points over the past year. The rebalancing of the economy from public jobs to private jobs is continuing apace: 5.67m people are now employed in the public sector, down 104,000 from a year earlier; 24.17m people are employed in the private sector, up 380,000.
Crucially, the rise in employment is not being driven by less work being shared among more people through part-time jobs. Total hours worked per week were a record 962.7m for July to September 2013, up 17.4m on a year earlier. The total amount of work now taking place in the UK economy is substantially greater than the 949.3m weekly hours seen in January to March 2008, the pre-recession peak.
Yet more output was produced at the time, despite those fewer hours; productivity measured as output per hour worked is thus significantly lower today. In fact, with working hours shooting up by around 1 per cent in the third quarter, and GDP growing supposedly by 0.8 per cent, productivity is still falling. That is the biggest explanation for our sluggish nominal wages, with inflation (still high but falling) pushing down real wages more than would otherwise be the case.
For the coalition, the problem is acute: it needs real wages to go up but doesn’t want rates to rise to tackle inflation and doesn’t want productivity to grow too fast in case this reduces job creation. It will be interesting to see how it tries to square that circle over the next few months.