Economic recovery has taken hold declares Bank of England. Experts now predict rate rise at end of 2015/start of 2016.

13th November 2013

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The Bank of England governor Mark Carney has declared that the UK recovery has taken hold.

The prospect of an increase in interest rates moved closer today as unemployment fell to 7.6% from 7.8% and the Bank of England predicted growth this year of 1.6% (from 1.4% previously) in its quarterly inflation report.

It now expects growth next year to be 2.8% rather than the 2.5% predicted in August.

The news comes hot on the heels of a fall in inflation to 2.2% on the Bank’s preferred measure, the Consumer Price Index this week, which led to some speculation that an interest rise had moved further away.

The Bank’s approach to interest rates is now at least partly based on unemployment falling to 7% as well at the supposedly firmer target of 2% inflation (which it has routinely missed for several years).

The Bank itself is acknowledging that unemployment now at 7.6% could fall to 7%. sooner than expected It doesn’t make an interest rate rise inevitable but it makes it much, much more likely.

It has given a range of forecasts of when it thinks unemployment could fall to 7%.

There is ‘only’ a two in five chance it will be at 7% by the end of 2014, a three in five chance by 2015 and a two in three change by the end of 2016.

Schroders’ view – a rise at the end of 2015

Giving his analysis, Azad Zangana, European Economist at Schroders says: “The Bank of England now forecasts the unemployment rate to hit the Bank’s 7% threshold in the second half of 2015, compared to previous guidance which assumed the threshold not being met before the middle of 2016. The latest figures on the unemployment rate show a fall to 7.6% in the three months to September. The change in guidance suggests the Bank of England thinks it will begin to consider raising interest rates over a year earlier than it thought only three months ago.

“The Bank of England also raised its average annual growth (GDP) forecast over the forecast horizon by about a quarter of a percentage point, but also cut its average annual inflation forecast by about 0.3%, suggesting a better trade-off between growth and inflation. When comparing the two forecasts that the MPC provided this month, the first used constant interest rates and the second used market interest rates (which are higher), the forecast using market rates has inflation just below 2% at the end of the forecast horizon, while the forecast using constant rates shows just above 2% inflation. This suggests that the Bank thinks the market is too aggressive in forecasting the first rise in interest rates in the middle of 2015, however, keeping interest rates on hold until the end of 2016 would on the other hand be too late.

” On balance, this leads us to bring forward our forecast for the first interest rate rise from the end of 2016, to the start of 2016, but we are not confident enough in the sustainability of the recovery to forecast tightening monetary policy in 2015, especially due to the poor productivity growth seen. The UK’s recovery has considerable momentum going into 2014, but whether the debt fuelled housing recovery translates into anything more than a short-term rebound in demand is questionable, particularly in the absence of wage growth outpacing inflation.”

Employment and unemployment

The unemployment rate has fallen to 7.6% with a drop of 48,000 in September to 2.47 million.

There are a record 29.95 million in work, but the employment rate remains lower than it was before the deep recession of 2008-09. The current rate of 71.8% compares with 73% at the peak in early 2008 explained by more people being in the workforce due to population changes.

TUC questions quality of jobs

The TUC has questioned the quality of the extra jobs arguing that Britain’s workforce is getting larger but poorer. TUC leader Frances O’Grady: “It is encouraging that more jobs are being created but job quality is falling and close to a 20-year low. A record number of people are stuck in part-time jobs because they can’t find full-time work, while real wages continue to shrink fast despite falling inflation.

“We need better jobs and healthier pay rises to tackle to the living standards crisis and ensure that the full benefits of recovery reach working people.”

According to the TUC’s jobs quality index launched this morning, job quality has fallen again and is close to its lowest point in the last 20-years.

Sterling strengthens

Andy Scott, premier account manager at foreign currency exchange brokers HiFX says: “Sterling hit session highs against the euro and the dollar Wednesday morning following the release of very strong employment data and an upbeat assessment of the U.K. economy by the Bank of England. In the Bank’s quarterly inflation report they dramatically changed their forecasts for when the employment trigger for a potential interest rate hike may happen from 2016, to possibly as early as the fourth quarter next year. They also increased their forecasts for GDP growth this year to 1.6% and next year to 2.8%. They did however state that they still intend to maintain exceptionally simulative policy stance until slack has reduced substantially giving themselves scope to keep interest rates on hold even when the 7% unemployment target is met.

“Such a large shift in the Bank’s forecast of when unemployment might reach the 7% trigger for raising interest rates seems to indicate that there remained a fair amount of doubt about the recovery continuing at the same pace we were seeing in August. In fact, it looks like the final quarter of this year could be the strongest of 2013 with the BoE forecasting growth of 0.9%”.

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