So why is the BOE apparently so reluctant to raise interest rates? One reason is that output is only just about to surpass its 2008 pre-crisis peak, and is far below the level it would have been had the economy kept growing at its long term trend. Unless we see many years of above trend growth, which seems unlikely, much of this “lost” output will never be made up. The recent rise in population also means that per capita output still remains below its pre-crisis peak. So while the change in economic activity has seen a distinct improvement, the level of activity remains some way below potential.
With many more people in part-time work, a high proportion of them say they want to work more hours. This also applies to a section of those in full-time work and the resultant level of underemployment plays a significant role in the MPC’s current assessment of spare capacity in the economy. Critics point out that the equilibrium level of underemployment is even harder to assess than the equilibrium unemployment rate, and that many people who say they would like to work longer are typically lower paid, younger and less productive employees, so that the output they generate will be less than 1 for 1 if indeed they do work more hours.
With the exact amount of spare capacity in the economy unknown, the MPC are watching wage behaviour as the key indicator of how quickly the labour market is tightening. Official data on average earnings growth and median pay settlements do not yet give cause for alarm, however the closely watched REC monthly survey on labour market conditions is beginning to flag warning signals. The permanent recruits salary reading in the latest survey has risen to a level just below its 2007 high and suggests that by the final quarter of this year, average earnings growth for all employees will have shown a significant pick-up. This increases the chance that MPC will increase rates before Christmas and some months ahead of market expectations.
