By Alex Dryden
On Wednesday two key economic reports, the labour market report and the Bank of England’s November Inflation Report, were released in the UK.
Both announcements were broadly positive. Unemployment fell to 7.6% in the three months to September, mirroring the stronger economic performance of the UK economy since the first quarter of this year. In the Inflation Report, the Bank of England revised its forecasts for unemployment to indicate that the 7% threshold will be reached by the third quarter of 2015 – 18 months earlier than forecast back in August. The underlying data in the UK labour report makes for interesting reading. The unemployment rate declined from 7.7% to 7.6% in the three months to September, beating expectations, which suggested that unemployment would hold steady at 7.7%. Unemployment is now at its lowest level since May 2009. Jobless claims also fell sharply in October, dropping by 42,000. This was significantly ahead of expectations, which suggested that claims would fall by 30,000. This stronger data was coupled with a positive revision to September’s drop in claims, from 42,000 to 45,000.
Wage growth remains a concern, however, with regular pay increasing by just 0.9% year on year. Excluding bonuses, wage growth was 0.8%, which is well below the annual rate of inflation, creating the possibility of weaker household demand in the future.
Nevertheless, the surprisingly robust UK economic recovery and falling unemployment have led the Bank of England to alter its projections for when unemployment will breach the 7% threshold – a necessary condition for an increase in interest rates. In July 2013 the Bank of England’s governor, Mark Carney, suggested unemployment was unlikely to reach 7% until the second quarter of 2016. However, unemployment is now expected to reach 7% by the third quarter of 2015.
The Bank of England’s forecasts are perhaps less important than the comments from its governor. Mark Carney reiterated that the 7% unemployment rate is a “staging post rather than a trigger” for a change to current monetary policy, and that the policy stance would be re-evaluated when the 7% unemployment target is reached. This indicates that interest rate rises should only be expected when the Bank of England is comfortable with the strength of economy activity and inflationary pressures.
The current view held by the Bank of England is that the recovery has taken hold, but that growth has not yet returned to normal. This is reflected in its unchanged forecast of 2% GDP growth in 2014 and 2.4% growth in 2015. The Bank of England expects a near-term decline in inflation due to a higher degree of spare capacity in the economy and the appreciation of sterling.
A revision to forecasts less than five months after they were originally released highlights how sensitive the Bank of England’s outlooks are to small changes in growth and to unemployment rates. It also illustrates that the Bank of England’s crystal ball is no more insightful than anyone else’s. The overarching message to investors is that UK interest rates will remain low for the foreseeable future and that the 7% unemployment target is a threshold, not a trigger, for future rate rises. However, with the UK economy strengthening faster than expected and the pace of recovery set to continue in the coming quarters, interest rates could rise sooner than anticipated. The pace of economic growth in the UK is faster than in other developed markets, providing a strong economic backdrop for UK-based equities.
Alex Dryden is a market analyst within the Global Market Insights Strategy team at JP Morgan Asset Management
Comments