UK interest rates have risen from 0.5% to 0.75% because the monetary policy committee (MPC) believes the labour market is at full employment and wage growth is set to explode. Pull the other one, it’s got bells on. I don’t buy it.
The pound initially rose on the news and then fell back by more than a cent against the US dollar in a sign that the markets didn’t like what they heard and didn’t believe the MPC’s claims either. The Institute of Directors came out against the increase, as have many economists who see no basis for a rise that lowers spending power. This in the same week when the Bank of Japan said it would loosen monetary policy further. Along with the European central bank it has negative rates and is still operating quantitative easing programmes.
Astonishingly, the decision to raise rates was a unanimous 9-0, which was a big surprise given there was essentially no hard data supportive of a rise. One smart journalist at the press conference suggested that this may well be an example of “group think” – so it’s OK if we are all wrong together. The reality is there are stronger arguments to be made for a cut in rates.
Personal insolvencies are up; there has been a slowing in the commercial property market, which is often suggestive of a slowing economy. The number of homes on the market is up but the number of buyers is not. The housing market is slowing, and raising the cost of a mortgage will slow it further. Brexit represents a major downside risk to the UK economy as does the possibility of trade wars.
The latest data from the Office for National Statistics shows that GDP growth was 0.2% in the three months to May 2018, the same rate as in the first quarter from January to March. Growth in the first quarter was lower than in 26 out of 28 EU countries; only Romania and Estonia were worse. The UK economy’s weakness doesn’t look temporary as the MPC claims. There is also no inflation to speak of, and no sign of a big pick-up coming. The consumer price index has come down from 3% in January to 2.4% in June 2018.
The MPC’s main reason for raising rates is that it believes, wrongly in my view, that wage growth is set to skyrocket. It isn’t. According to the UK’s national pay statistic average weekly earnings, total pay growth averaged at 4.3% from January 2001 to March 2008, just before the onset of recession in April 2008. From that point through to the end of 2017 wage growth averaged 1.8%. It picked up a little in the last year and now stands at 2.5%, down from 3.1% in December 2017. In its last 18 forecasts in a row, the MPC wrongly forecast that wage growth was going to return to pre-recession levels of around 4% or so. The MPC has cried wolf in its past 18 forecasts, including this one, and I see no reason to believe it is right this time. Wage growth is slowing.
My research with economist David Bell suggests that the UK is a long way from full employment. It is underemployment, not unemployment that is impacting wage growth, and that has not returned to pre-recession levels. When full employment is reached, wage growth will start to strengthen towards 4%. That isn’t going to happen any time soon. The MPC has just made a major error it will have to reverse fairly quickly as bad data flows in. I have deja vu of 2008.
• David Blanchflower is a professor of economics at Dartmouth College, New Hampshire