The UK unemployment rate has fallen to the lowest level in five years, dropping just below the 7.0% threshold that the Bank of England had set for when it might consider raising interest rates, reports Richard Barley for The Wall Street Journal. But that doesn’t mean the BoE is eager to do so – it had assumed that 7% unemployment was still a few years away instead of just eight months when Bank of England governor Mark Carney (who was new to the job at the time) tied interest rate guidance to the unemployment rate last August.
Despite UK’s unemployment, economy could still have more than 1% slack
Now the question is how much slack remains in the British economy. Even at 6.9%, UK unemployment is still a good half a percentage point above typical levels. Add in the number of people who are working part time jobs when they’d really rather be full-time and there could be another 1% or more worth of slack, giving the BoE a reason not to raise rates if it would rather hold off.
The U.S. Federal Reserve is treading carefully with raising rates amid the widespread economic, macro and geopolitical uncertainties sweeping around the world. The Fed raised its target level as high as 20% in the early 1980s to deal with runaway inflation, but we're a far cry from that today — a time when inflation threatens Read More
The other problem is that many of the people who have come off the unemployment rolls are self-employed, and there is reason to doubt that all of those jobs will last. Even in normal circumstances entrepreneurship doesn’t have a high rate of success, and some people may have started their own businesses out of frustration with a difficult job market, not because they had great prospects.
Policy ‘knockouts’ still worth watching
Even though the unemployment rate has crossed the BoE’s line in the sand, that doesn’t mean it is in any rush to abandon its accommodative monetary policy, and it could be more informative to look at the ‘knockouts’ that Carney put in place that would have forced him to raise rates before unemployment was under control.
The first two knockouts are both concerned with inflation. If the UK’s Monetary Policy Committee (MPC) decides that it think the 18 – 24 month consumer price index (CPI) will be above 2.5% (compared to a 2.0% target) or if it thinks that medium-term inflation is no longer ‘sufficiently well-anchored’ then the BoE would be able to adjust interest rates to deal with that inflation. Also, if the Financial Policy Committee (FPC) were to decide for any reason that such low rates threatened the stability of the British financial system then the policy also end.
But the CPI is still well under 2.0% and while some people think that the accommodative monetary policies we’re seeing worldwide will harm long-term growth, they don’t seem to be driving instability now. As long as both those things are true, Carney will probably keep rates quite low to give the economy more time to recover.