The Federal Reserve edged a step closer to an interest rate hike on Wednesday, preparing the ground for a possible December increase. If it comes, it will be the first change in the benchmark US interest rate since 2008.
It’s widely accepted that the Bank of England will be next to pull the trigger, likely within the first six months after the Fed. The BoE has often hiked fairly quickly after the Fed in the past, and markets don’t expect governor Mark Carney to jump the gun.
But in a note this morning, HSBC economist Liz Martins makes the case that “it may be the UK that needs to tighten more urgently,” based on the country’s increasingly strong-looking labour market.
It was widely accepted until relatively recently that the UK recovery was considerably weaker than the US recovery. In fact, that’s not quite correct. The UK’s post-financial crisis recession was worse than the US’, but the recoveries have been almost identical.
Since early 2012, the UK and US labour markets have looked pretty similar based on the headline number that’s focused on most of all — unemployment. Both countries had unemployment rates which fell from around 8% then to about 5.5% by the turn of this year.
But under the hood, something dramatically different is going on. The unemployment rate only measures the proportion of people out of work and actively looking. It doesn’t include people who’ve dropped out of the labour force entirely: Those who aren’t working and aren’t looking either.
So when you measure participation — the proportion of 16-64-year-olds in the labour force, either in employment or out of work and looking — the US looks much worse than the UK.
While UK participation is near record highs, US participation is hitting multi-decade lows. If a lot of those workers dropped out of the labour force because they’re simply discouraged from looking for work, then the unemployment rate becomes a less accurate measure for assessing how much slack there is in the economy.
Both the BoE and Fed target inflation at about 2%, and the less slack there is in the economy, the more inflation that the current low interest rates in both countries should generate. The most important task for both central banks is working out how close to full capacity (or zero slack) an economy.
Liz Martins also noted that “wage growth and service price inflation is rising faster, the savings rate is falling and productivity is picking up only slowly” in the UK. Inflation staying low is in part based on Bank of England forecasts for stronger productivity, which have been repeatedly revised down.
The UK’s self-employment boom could also have hidden some slack. There might be low-paid workers registered as freelancers who’d much prefer the security of permanent contracts, and that could represent hidden slack in the economy.
But on the surface, the supply-side of the UK labour market looks a lot stronger than the US, and the UK might be better off hiking interest rates first.
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