Unemployment falls to 2.2 million but Bank of England still sees slack in the system

14th May 2014

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The number of people out of work has fallen by 133,000 to a new five-year low of 2.2 million in the three months to March, says the Office for National Statistics.

The unemployment rate now stands at 6.8% with numbers in employment rising to 30.43 million. Yet growth in average earnings was unchanged, with pay in the three months to March up 1.7% from a year earlier.

It means earnings rose faster than inflation for the first time in nearly six years. Meanwhile the Bank of England left its growth forecast for 2014 unchanged at 3.4%, but revised up its forecast for 2015 to 2.9% from 2.7%.

However, the Bank has played down the prospect of any swift rise in interest rates in its inflation report. The report said: “The committee judged that there was scope to make further inroads into slack before an increase in Bank rate was necessary.”

Ben Brettell, economics editor, Hargreaves Lansdown says: “Mark Carney continues to walk the tightrope between talking up the UK economy and dampening expectations that interest rates will rise.

“The degree of slack in the labour market is key. The Bank noted that despite the continuing fall in unemployment, it remains historically high. Productivity growth is yet to emerge, and the number of people reporting they would like to work longer hours points to significant spare capacity. This means there is scope for the economy to grow further without pushing up inflation, which in turn means no rate rise is necessary.”

“All this suggests that unless inflation expectations really start to take off, the Bank will judge that there is enough slack in the economy to keep rates on hold for a while yet. They will need a clear and unequivocal reason to raise them, as the risks of tightening too early are substantial. Are households and companies capable of withstanding higher rates? The answer is we simply don’t know.

“Expectations rates might rise as early as this year are probably unfounded – it looks likely the first rise won’t come until 2015, and quite possibly after May’s election. However, of much more interest to mortgage-holders, savers and investors is where rates might end up. On this subject the Bank of England has been fairly clear – it expects rates to stabilise at much lower levels than we saw pre-crisis. A peak of 2-3% looks more likely than 5-6%.”

Self employed flattering employment numbers?

Schroders European Economist, Azad Zangana says: “The latest Labour market statistics revealed another large rise in the number of self-employed, which are helping to lower the unemployment rate, but may be overstating the recovery in the labour market.

“The headline UK unemployment rate fell to 6.8% in the first quarter of the year, compared to 7.2% at the end of 2013. The unemployment rate is now at its lowest level since the fourth quarter of 2008, but the nature of the fall is overstating the improvement. Of the 283k jobs created in the first quarter, a huge 183k were by the self-employed. Only 58k full-time employees gained work over the period. In fact, the number of full-time employees remains 183k below its previous peak in 2008.

“While there is no doubt that work patterns are changing to increase flexibility for both employers and employees, we are concerned that the shift away from full-time formal employment is contributing to the dismal productivity growth the economy has seen in recent years.

“Moreover, we suspect that a large proportion of the recently self-employed would return to being employees once the economy accelerates further. This is significant as it suggests that there is a greater degree of slack in the labour market, which bears down on the growth in wages. Indeed, looking at the latest pay growth figures, the city consensus was disappointed with just 1.7% average weekly earnings growth compared to a year earlier, whereas the consensus was for a pick up to 2.1%.”

Impact on sterling

Zangana adds: “The reaction from markets has been negative for sterling, and positive for Gilts (lower yields). The Bank of England, which presents its Inflation Report later this morning, is likely to view the latest labour market data as softer than they would have hoped – suggesting that interest rates could be kept on hold for longer than previously expected. Indeed, with GDP growth and CPI inflation coming in lower than the Bank’s forecast in the first quarter, we expect a dovish statement from Governor Mark Carney.”

Chris Towner, director of FX advisory services at HiFX discussing the unemployment figures, says: “Unemployment takes another welcome dip to a 5-year low of 6.8% as the sun continues to shine on the UK. The Office for National Statistics recorded 283k jobs created in the last quarter, which is the largest quarterly increase since records began back in 1971.

“The question to ask now is how long will the good news continue to come or are clouds appearing on the horizon? For now things are looking good as the economy continues to grow at enviable levels and inflation remains under control. This is helping sterling strengthen against the euro, which has jumped by almost 8% since last summer and with further easing expected in Europe, this positive momentum can continue for some time to come. The one thing to keep an eye on is the slowing inflation rate as average earnings dipping to 1.3% combined with a strengthening currency could lead to a lower CPI reading in the months ahead. A drop below 1% would require the Governor to write a letter to the Chancellor explaining why.”

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