Rate speculation after jobless fall

Thursday 23 January 2014

Unemployment has fallen to within a whisker of the Bank of England's threshold for considering raising interest rates - prompting speculation that they could go up as early as this year.

Official figures showed the jobless rate had dropped more sharply than expected to 7.1% in the quarter to November, as the number of those out of work fell to a near five-year low of 2.32 million. An additional 280,000 people were in employment over the latest quarter, representing the biggest quarterly increase on record.

The improvement in UK jobs was widely welcomed by politicians but the possible implications for interest rate policy - which could affect the cost of mortgages and business borrowing - was carefully scrutinised by economists.

The figures from the Office for National Statistics (ONS) mean that unemployment is closing in on the "forward guidance" target of 7% set by the Bank's policymakers only last August.

The guidance was designed to give confidence to households and firms that access to finance would remain cheap while the economy was nursed back to health.

Rates have been held at an historic low of 0.5% since March 2009 and at the time of setting the guidance policy, the Bank's forecasts for unemployment meant officials did not expect to have to consider raising them until late 2016 at the earliest.

But the quicker than expected pace of falling unemployment - down from 7.4% in the quarter to October - has prompted markets to bring forward the date of an expected increase in the rate.

This has fuelled speculation that policymakers will change the guidance, probably by lowering the target to 6.5%, to head off fears of a rate rise. Some have also suggested linking a change to an increase in wage growth to above the level of inflation.

Newly-published minutes of the Bank's meeting earlier this month showed the nine members of the Monetary Policy Committee (MPC) saw "no immediate need to raise rates" regardless of plunging unemployment.

But they conceded that the 7% threshold could be reached "materially earlier than previously expected" as the recovery gathers pace.

Meanwhile, the possibility of bolstering forward guidance - which has been hinted at in speeches by MPC members - was not apparently discussed.

Policymakers said that when the time does come for rates to be raised "it would be appropriate to do so only gradually".

Investec economist Philip Shaw said: "We had expected members to have discussed various options surrounding a possible shift in their guidance. However no such debate took place."

But he added that language about some technical aspects of unemployment data could be taken as a sign that the committee believed the forward guidance threshold was too high and might need to be reduced.

Andrew Goodwin, senior economic adviser to the EY ITEM Club, said: "We expect the threshold to be lowered to 6.5%, but the MPC should not stop there; an additional condition based on real wage growth should be introduced.

"As the minutes make clear, there is no prospect of a rate rise in the near future. Raising interest rates too soon, before real wages have begun to improve and growth has broadened out, could risk choking off the fragile consumer-led recovery."

But James Knightley of ING Bank said that with prospects for the economy improving and the clear threat of the 7% threshold being breached in the next month or two, the probability of an interest rate rise this year was increasing.

On the FTSE 100, fears of an earlier-than-expected rise held back shares, with early gains in trading falling away to leave the index in subdued mood.

But the speculation bolstered the pound, which climbed to almost 1.66 US dollars, nearing a two-and-a-half year high reached earlier this month.

Today's ONS data also showed that despite inflation slowing to 2%, pressure on household incomes remained as wage growth lagged behind at 0.9%

Prime Minister David Cameron tweeted: "The biggest quarterly increase in employment on record. More jobs means more security, peace of mind and opportunity for the British people."

But TUC general secretary Frances O'Grady said: "While headline unemployment is within a whisker of the Bank's forward guidance threshold, an early interest rate rise would clobber mortgage-holders and businesses - jeopardising our economic recovery."