Hamish McRae: Higher unemployment, inflation and interest rates. But does it matter?

While most of us will ride through these pressures without much trouble, some will find it tough
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The Independent Online

Yesterday the news was higher unemployment; the day before it was higher inflation; and last week it was higher interest rates. That does not sound too great, does it? Is this serious or is it the usual mix of economic news you would expect at this stage of the cycle?

I think it is mostly the latter but with a couple of unusual twists.

The new numbers first. The Bank of England's Inflation Report published yesterday put a slightly better gloss on some iffy inflation figures for October, out on Tuesday. These had showed that the year-on-year rise in inflation on the new consumer price index is 2.5 per cent a year, while the old retail price index - the one still used for many things including setting the return on index-linked gilts - is at 3.7 per cent. Chris Watling at Longview Economics points out that this is the highest since June 1998, while trend CPI, on a six-month moving average, is at a 10-year high.

The Bank has to write a letter to the Chancellor if CPI inflation diverges more than 1 per cent on either side of a target of 2 per cent, so there is some leeway as far as its statutory duty is concerned. Further, its present forecasts for inflation based on market expectations for interest rates show it coming back towards the 2 per cent level. But market rates average 5.1 per cent for the next couple of years.

"And that" David Hillier of Barclays Capital points out, "means rates above 5 per cent for more or less the whole of the next two years. Admittedly, not much above 5 per cent - the rates used by the Committee average out to 5.1 per cent - but above 5 per cent nonetheless."

I think that is right. The market read the Bank's comments on the Inflation Report to suggest that we should not expect a rise in rates. But I think we have to assume that there is a very good chance that there will be some further rise in rates next year and no significant decline over the next two years.

If inflation is the highest it has been for the best part of a decade, in effect the highest it has been since the Tories were in power, what about unemployment?

Yesterday we got the new Labour Market Statistics. Unemployment at 5.6 per cent on the International Labour Office measure is now at its highest level since 2000. If you want comfort on the inflation front, headline growth in average earnings was only 3.9 per cent annual rate during the three months to end-September, which is fine. But that is not much comfort for people who don't have the skills to compete in the marketplace for new talents. Manufacturing jobs fell by 77,000 to about 3 million, which is apparently the lowest level since records began in 1841.

The most interesting thing, however, is the extent to which those "old" jobs have been replaced by new ones. Total employment is now just on 29 million. So there is this paradox: unemployment is at a seven-year high yet far more people are employed than at any time in our history.

The explanation comes in two parts. One is that there has been a sharp increase in the size of the workforce. This has been partly a function of inward migration from the new EU member states, most obviously Poland, and partly because older workers who had retired are coming back to work. This latter feature has not attracted the same attention but seems to have been almost as important.

The other part of the explanation is that there has been a shift in the structure of work: not just the move out of manufacturing and into services but also out of full-time employment into part-time jobs. The number of people in full-time work actually fell by 15,000 in the three-month period, whereas the number of part-timers rose by 70,000. The trend in the total number of hours worked is still rising and that is the best measure of the underlying strength of the demand for labour but the very latest data does suggest some slowing. Most part-timers do so from choice but not all of them do. If you lose a full-time job and replace it with a part-time one that is likely to put pressure on family budgets.

That leads to what must surely be the prime question posed by this juxtaposition of higher inflation, higher unemployment and higher interest rates: how stretched are people with high borrowings?

I have been looking at some work by GFC Economics, which suggests that while we are not yet back to the pressures of the early 1990s we are getting closer. Interest rates are much lower than in 1990 but the debts are much larger, so the burden is becoming similar. It is hard to do the sums with any precision, partly because a lot of mortgage debt is on fixed rates. This delays the impact of rate increases but it does not eliminate them as these fixed deals come up for renegotiation. So as a result of the two increases in interest rates there is already an increased burden in the pipeline. And, a further point, while low interest rates cut the servicing burden, they don't cut the repayment burden. Eventually mortgages have to be repaid.

At any rate, as you can see from the final graph, the burden has been rising fast. GFC calculates that another rate rise to 5.25 per cent would push servicing to 14.6 per cent of disposable income, not far short of the 15.3 per cent peak that caused so much damage in the early 1990s.

That seems to me to be the core issue. If you look at the overall picture, everything looks pretty much OK. Growth is good; employment is strong; inflation is under control; and people seem to be managing at the present level of interest rates. But that is the overall picture. Within the vast spectrum of the 25.3 million households in the UK, most are all right. Some are doing wonderfully: the stars of financial services and the entertainment industries and the people who supply goods and services to them. If you look geographically, most regions are all right too and some places are booming as never before.

However, averages conceal extremes and some people in less favoured occupations or less favoured regions are suffering. Indeed, many people are under pressure simply because they are at the wrong stage of their life: big mortgage, children, maybe other family responsibilities, maybe a job that however essential to the community does not pay particularly well.

So while most of us will be able to ride through these mounting pressures without too much trouble, some people will find it very tough. If the conventional wisdom that the peak of interest rates is either 5 or 5.25 per cent proves wrong and the peak is higher, then there will be a lot of pressure on quite a lot of people. The rises in both inflation and unemployment have been so gradual that they have escaped much notice. They have crept up on us. It takes a week like this one to make you stop and ponder.

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