Unemployment falls to six-year low: what it means for household finances, interest rates and the pound

18th February 2015


Unemployment fell to a six-year low of 5.7% in the three months to December, official  figures reveal.

Office for National Statistics data released today showed that  30.9m people were in work, an increase of 608,000 from a year earlier.

Average weekly earnings increased by 2.1% including bonuses and by 1.7% excluding bonuses in the three months to December compared with a year earlier.

Minutes released today showed the Bank of England’s Monetary Policy Committee voted 9-0 to leave interest rates on hold for the second month in row. The weakening outlook for inflation had forced MPC members McCafferty and Weale to abandon previous calls for a rate rise last month.

What does it mean for household finances?

Ben Brettell, senior economist at Hargreaves Lansdown, said that this signifies meaningful real wage growth is starting to emerge, which, combined with inflation at 0.3% and falling, will substantially reduce the squeeze on household budgets.

Howard Archer, chief UK and European economist at IHS Global Insight, said: “Earnings growth is now markedly above inflation, which is very good news for households and for consumer spending prospects in 2015.

“It is also potentially good news for the government as the Conservatives and Liberal Democrats will both be hoping that rising real earnings growth will make people feel happier about life and more inclined to vote for them as May’s general election draws ever closer.

“Furthermore, the prospects for real earnings growth look bright for the coming months, with earnings growth likely to rise and inflation set to dip even further from just 0.3% in January (indeed mild deflation is possible for a while over the coming months).

“There is the possibility though that a number of employers will use very low inflation as a reason to limit pay 2015 increases; this could potentially stretch some workers stretched when inflation moves back up.”

What does it mean for interest rates?

Brettell said: “The Bank of England noted that the pickup in pay growth has been faster than it had anticipated. It had previously said that it wants to see a marked increase in pay before judging that sufficient labour market slack has been eroded for interest rates to rise.

“If pay growth continues to improve, this removes a key barrier to higher interest rates. However, productivity growth is perhaps the most important factor here: if productivity can increase, the economy has greater potential to grow without causing inflation. If productivity growth remains sluggish, inflationary pressures could build and interest rates might have to rise sooner.”

However, given that inflation is expected to fall below zero in the coming months, and stay close to zero for the rest of the year, there is no pressure on the Bank to raise interest rates in the short term, he explained.

Brettell added: “Indeed Mark Carney indicated last week that the Bank would even consider cutting rates if deflation looked like it was becoming entrenched. With inflation likely to pick up once the effect of the drop in oil prices falls out of the year-on-year calculation, a cut in rates looks most unlikely, but I don’t see them rising until mid-2016 at the earliest.”

Despite falling inflation, the Bank of England appears increasingly optimistic about the economy, noting that the modest slowdown experienced towards the end of 2014 might be short-lived, and that consumption growth looks likely to be robust, said Brettell.

Archer said: “We remain firmly of the view that the next move in interest rates will be up. Furthermore, we certainly would not rule out a hike from 0.50% to 0.75% before the end of 2015, although a move around February 2016 currently looks most likely to us.

“Regardless of whether the Bank of England first acts late on in 2015 or waits until early 2016, we see interest rates rising gradually to 1.50% at the end of 2016 and to 2.50% at the end of 2017. This is based on our expectation that growth will hold up pretty well and that consumer price inflation will get back up to 2.0% by early-2017.

“Even so, the Bank of England will not raise interest rates aggressively because of a combination of factors including still relatively high consumer debt levels, the potential impact on sterling and the risks to UK growth coming from extended Eurozone weakness.”

What does it mean for sterling?

Andy Scott, associate director of FX advisory services at foreign currency specialists, HiFX, said: “This morning’s Bank of England minutes and unemployment data appear to be in line with what we heard at last week’s inflation report.

“There’s still a lot of uncertainty over the forecast horizon but the message from the Bank of England seems to be that they could raise interest rates earlier than markets expect i.e., this year. We still see that as a relatively slim chance given all of the other downside factors that look set to weigh on consumer price inflation and with the U.S. and Chinese economies slowing, it seems prudent to keep monetary policy expansive.

“Sterling reacted positively to the both the minutes and the employment data as it reintroduces the possibility of a rate hike this year. One thing we haven’t heard the MPC mention yet however is the strength of sterling over the past year, which reached a multi-year high on a trade weighted basis – even though it’s weakened against the U.S. dollar. A strong currency when you’re faced with disinflation can add to the problem, and we see this as something that’s likely to register on the BoE’s radar in the months ahead.”

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