Wage growth and migration could hold the key to UK interest rates
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Version 0 of 1. Bank of England policymaker Ian McCafferty excludes two essential trends from his analysis of the economy. In a speech this week, he said a bounce back from a lacklustre first three months of the year was on the cards. With the recovery will come a steady rise in wages that will last the rest of this year and into the next, resulting in the first of several interest rate rises next spring. It’s not an outlandish statement. An interest rate rise in the first quarter of 2016 is what the market expects, too. Of course, McCafferty is more circumspect than that. Speaking in London, he said that he recognises things can change, as they have so often in the last few years to delay lifting rates from 0.5%. Standard & Poor’s warning that UK growth is threatened by the EU referendum and a loss of business confidence is a case in point. Yet higher interest rates in less than a year qualifies as his central view, as it does the MPC’s. So what is missing? First there is the recognition by the Office for Budget Responsibility that net migration in Britain has ballooned. Last year, net migration to the UK increased by 318,000. This year could be the same or even higher. To give some sense of the rise, Britain is now a country of 64.1 million people, more than 4 million more than in 2004. The OBR acknowledges the latest data, and adopts the long run trend in its forecasts to the 2060s. Discounting recent bumper migration totals, the longer-term trend is much lower, though it is rising and by a large percentage. In its report on Wednesday, it said the upward trend has forced it to abandon the standard 105,000 a year increase in favour of a higher 165,000 a year. Using this figure, the working age population will, on a conservative estimate, be at least 500,000 higher by the next election. This trend undermines McCafferty’s assertion that spare capacity in the economy is a fixed entity and will soon be almost entirely be used up, pushing wages up “markedly”. He estimates the output gap at 0.5%. This is based on surveys showing workers want their employers to give them more hours and that the long run unemployment rate is 5% and not the current 5.5%. By the end of the year most people will be working all the hours they want and unemployment will have fallen further, forcing employers to hike wages. This might be true of the current working age population. Is it true when there are 100,000 or more people joining the workforce each year? Surely, they will keep wages in check. Next is the chancellor’s new mission to cut public services and welfare payments to generate year-on-year budget surpluses. Set aside for a minute the OBR view that his target is ambitious. Let’s take Osborne at his word and look at the broader effect on the economy. Without any doubt it will prove a drag on growth. It is always difficult to estimate, but cutting state spending, whatever its proponents claim as the long term benefits, is going to hit consumption over the next year or three. In the last year the economy has slowed, primarily in response to a clampdown by regulators on previously rampant property lending. It sapped consumer confidence, which has bounced back, but not with any conviction. The chancellor wants consumers to spend their wages while the government steps back, something they appear unwilling to do. Sidestepping these issues, the Bank of England still expects growth to pick up and wages to continue outstripping inflation by a large margin. It may be this secondary effect that eludes the UK and keeps interest rates at or near its historic low for a very long time. |