Carney’s Labor Puzzle Gains Urgency as BOE’s 7% Looms
Bank of England officials’ quest to understand the strength of Britain’s labor market will take on greater urgency this week if unemployment keeps falling as fast economists predict.
The jobless rate declined to 7.3 percent in the three months through November, economists said before a report tomorrow, bringing it even closer to the 7 percent threshold at which officials have said they will review borrowing costs. That may add pressure on the MPC to reassess its guidance policy, even as it seems no closer to understanding the reasons for the labor market’s health.
The puzzle of productivity and payrolls bedeviling U.K. economic analysis is a “perennial problem,” Monetary Policy Committee member Ben Broadbent said last week. An insight into the debate will be revealed tomorrow when minutes of the MPC’s January meeting are also published. Officials previously acknowledged a “range of views” on the matter.
“Rephrasing and redesigning guidance is going to be pretty challenging because the jobless threshold was a compromise across all of the committee,” said Neville Hill, an economist at Credit Suisse Group AG in London and a former Treasury official. “It will be much harder for them to compromise or agree on the right diagnosis for the U.K. economy in this environment. There will probably be some disagreement on how strongly productivity can recover.”
The unemployment rate measured by International Labour Organization methods declined from 7.4 percent in the three months period through October, according to the median of 33 estimates in the Bloomberg survey. Eleven predict it will fall to 7.2 percent, while one sees an increase to 7.5 percent.
Britain’s economy is heading for its strongest expansion since 2007, and the International Monetary Fund raised its U.K. growth forecast today by more than for any other Group of Seven economy. The Washington-based group sees expansion of 2.4 percent this year and 2.2 percent in 2015, up from October predictions of 1.9 percent and 2 percent, respectively.
While the economic rebound has helped push the jobless rate down, labor productivity, measured on an output per hour basis, slid in the third quarter.
The test for BOE Governor Mark Carney will be securing the MPC’s support for any fine-tuning of guidance, which he unveiled in August to reassure Britons the BOE wouldn’t begin raising interest rates too soon. Carney failed to get unanimity on the policy that month, when Martin Weale voted against it because of inflation concerns.
“The rapid drop in unemployment will force the bank to consider an evolution” to guidance, said Sam Hill, an economist at RBC Capital Markets in London. “The more the unemployment picture improves, there’s more likelihood that there will be a differential of views within the committee. When unemployment was higher it was probably much easier to gather consensus.”
An index of factory payrolls rose in January from October, the Confederation of British Industry said in a report today. It also said manufacturers’ hiring intentions for the next three months are the most optimistic since April 2012.
Carney said last month that the recovery will “need to be sustained for a period before productivity, and real wage gains can resume.” Policy makers “don’t know how much productivity will come back,” Deputy Governor Charlie Bean said in November.
It’s the “principal forecast uncertainty,” Goldman Sachs Group Inc. economist Andrew Benito wrote in a note to clients last week. The MPC may favor a strategy that “buys more time to clarify some key macro forecast uncertainties,” he wrote.
Output per worker is almost 16 percent lower than it would have been if it had continued on its pre-recession trend, according to the E&Y Item Club, which recommends policy makers consider modifying guidance to add a link to real wages. In the first nine months of 2013 “the level of output per hour has been slightly lower than the average level in 2012 and around 2 percentage points lower than in 2011,” the ONS said on Dec. 24.
“The whole debate about productivity has become very conflated with what’s happening in the short-term,” said Malcolm Barr, an economist at JPMorgan in London. “The MPC are being forced, by the choice of unemployment as a variable, to make some judgments about that outlook in a very uncertain space and over a very short time window.”
Policy makers have used the term “productivity puzzle” to describe how the economy continued to create jobs throughout the economic slump. Now, as the economy starts to pick up, unemployment continues to drop and productivity stays weak, solving it is central to their outlook.
The MPC has “a range of views” about the productivity outlook, officials said in their quarterly Inflation Report in November. “The MPC’s best collective judgment remains that productivity is likely to increase as the economy recovers.”
Item Club recommended that the MPC wait for a pickup in wage growth before increasing interest rates. Annual pay growth held at 0.8 percent in the three months through October, less than half the pace of inflation. It probably increased to 1 percent in the quarter through November, according to a survey.
The situation of households is “far less favorable than might be suggested by an assessment” of falling unemployment, said Nathalie Dezeure, an economist at Natixis. “The BOE is unlikely to raise its rates until there is a more significant and sustained improvement in household income.”
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