Bank tells Clarke to act now
Thursday 13 February 1997
"There should be a rise in interest rates now. The longer you delay, the more interest rates will have to go up to have the same effect," said Mervyn King, the Bank's chief economist, commenting on the latest quarterly Inflation Report.
He said that although the claimant count was exaggerating the fall in unemployment, there had been a clear tightening in the labour market. Tax cuts and up to pounds 22.4bn in "windfalls" of building society shares meant the prospects were for strong consumer demand and investment growth.
The Bank has revised down its short-term inflation forecast because of the strong pound, but revised up the outlook two years ahead. It puts the target measure at 3 per cent and rising in 1998.
Mr King said: "The rise in the pound does help push inflation lower in the short term." But he gave a clear signal the Bank thinks the Chancellor should have already increased the cost of borrowing: "We are in an upturn and it would be normal for interest rates to rise. They are at the same level as they were in the middle of last year."
The report concluded: "The Bank continues to see the need for a moderate tightening of policy." On Tuesday night Howard Davies, the Bank's deputy governor, had signalled that a quarter-point rise to 6.25 per cent would do the trick.
The tone of yesterday's Inflation Report was not quite as tough as Mr King's comments. It pointed out that the Bank's forecast for inflation is actually more optimistic than many others.
Even so, there were mixed reactions to the Bank's fresh call for higher borrowing costs. Mr Clarke was not the only person to reject this as unnecessary.
"Sterling's rise will hit exports, slowing the pace of growth and lowering the risks of capacity constraints," Michael Saunders at investment bank Salomon Brothers said. But other City economists backed the Bank. "The price of laxity now is likely to be higher base rates in the longer run - a price unlikely to be paid by the current Chancellor of the Exchequer," said Adam Cole at James Capel.
The Bank's warning that the labour market was getting tighter, contributing to inflationary pressures, was borne out by new Government statistics.
Unemployment fell by a much bigger than expected 67,800 in January, according to the Government's figures, leaving 1,385,300 men and 430,000 women still on the dole. The claimant count has now fallen by a record average of 70,000 a month over the past three months, pushing the unemployment rate down to 6.5 per cent - 1 percentage point above the lowest level in April 1990.
Eric Forth, employment minister, said the 6 per cent barrier was in sight. However, officials admitted the recent introduction of the Jobseekers Allowance (JSA) means the figures cannot be relied upon as an estimate of the number of people leaving unemployment for new jobs.
According to Simon Briscoe, an economist at Nikko, the changes "have made the interpretation of the monthly unemployment figures impossible". The more reliable Labour Force Survey shows unemployment falling at a much slower rate.
But other indicators suggest the labour market is tightening, as the Bank claims. Average earnings grew by 4.25 per cent in 1996, compared with 3.25 per cent in 1995. Pay settlements have hardly increased, so the rise reflects higher bonuses and overtime payments. The Inflation Report says "earnings growth is already close to the maximum likely to be consistent with the current inflation target".
David Walton of Goldman Sachs said: "Even allowing for the JSA, these numbers suggest that the labour market is tightening much too rapidly for comfort. This carries a real danger of higher wage inflation during 1997, with consequent risks for retail price inflation in 1998."
However, the Government will find some comfort in the fact that productivity is rising and the growth in unit labour costs for companies has slowed.
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