Hamish McRae: Revised inflation figures mean the outlook is still dismal for savers

Economic View: In the US by contrast the mood has shifted towards a rise in interest rates coming quite soon

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If the next five years look like being a parliament of pain for British taxpayers, they also seem likely to become a dismal few years for savers. Working people, by contrast, may do quite well, getting much of the increase in real wages from falling prices rather than higher wages.

There was a big dump of information about the UK economy today, and whenever that happens it is usually best to let it settle a bit before drawing overly firm conclusions. We should certainly wait for the minutes of the Monetary Policy Committee, which are to be published next week. But the downward revision of inflation expectations from the Bank of England is important, and the slight rise in money wages matters too.

There are two main drivers behind the revised inflation projections. One is the fall in energy prices, the other stagnation in Europe. The former is benign, the latter corrosive. These are just projections and they may be wrong, but they have transformed the markets’ perception of the path of UK interest rates. The economy is growing pretty much as expected and the slack in the labour market is still being mopped up, but whatever the long-term argument for starting to lean against above-trend growth, it is a bit tricky to stick up interest rates when you are about to write to the Chancellor explaining why inflation is well below target.


For savers, however, this is a bit of a disaster. It is implicit in the Bank of England’s forecast that real interest rates, which have been negative for six years, will gradually climb back towards zero over the next three years. But some calculations by Fathom Consulting suggest that there is less slack in the economy that the Bank thinks and that inflation may be higher as a result. If that is right, the real interest rate will remain sharply negative, as you can see in the top graph. And if that is right, the pressure on savers to do something – anything – to get some sort of real return cranks up further.

This is not good. There have been two sustained periods of negative interest rates since the Second World War, the first through to the middle 1950s, the second during the 1970s. The first is the more relevant, for the second was a function of double-digit inflation with interest rates lagging behind – obviously not the situation now. During the late 1940s and early 1950s there was huge demand for funds for reconstruction and an overriding need to hold down the cost of funding the huge national debt. The only way to fund the former and cut the latter was, put bluntly, to defraud savers. After a while savers caught on and started to shift funds out of gilts and put them into property and equities.

No parallels are exact, but we are facing something like that now. We passed the turning point in both US and UK bond yields a couple of years ago, so you could say the long bear market in our bonds has begun, but in Europe the prospect of deflation has pushed German Bunds down to new lows. Today the yield on 10-year Bunds was 0.82 per cent. Germany, on this measure, is the new Japan. Better to buy a flat in Berlin. It looks very much as though the European Central Bank will be forced into quantitative easing and as for any rise in eurozone interest rates, well, that is in the distant future.

In the US by contrast the mood has shifted towards a rise in interest rates coming quite soon. It is even conceivable that dollar rates will rise ahead of sterling rates. As my colleague Ben Chu reports on page 57, the market is now expecting UK rates to go up in the second half of next year. Capital Economics notes the Federal Reserve is running out of excuses not to increase rates, and the first rise there may come earlier than the markets expect, perhaps next March.

The thing pushing the Fed will be higher wages. Wages are increasing here too. Deutsche Bank put out a note pointing out that over the past three months UK earnings are up 4.5 per cent on an annual basis. That nudges us into the great debate about the spare capacity in the economy and in particular in the labour market. Most of the data is pretty mushy. We don’t really know what earnings are, for the consumption figures suggest it has been rather faster than the official numbers. Nor do we have much of a handle on output of service industries, always hard to measure but harder now as a result of rising self-employment. What we can, however, be reasonably sure about is the overall level of employment – and here I find the bottom chart the most illuminating.

As you can see, the level of employment as a proportion of people of working age is the highest it has been since the early 1970s, and now a touch above the average level during the strong growth period between 2000 and 2007. We are not, as a country, quite working flat out, and it is possible that we can push up the labour participation rate a bit further. But as Credit Suisse, which drew attention to the strength of the labour market, noted there are risks inherent in the Bank’s dovish policy on interest rates.

You might say, with real wages rising at last, about time too. Actually real wages have probably been rising for months already but the figures have not fully caught up. But now there is no doubt. Couple that with cheaper energy prices and UK working people may at last start to feel richer.

As for savers, it looks likely they will have to wait until spring for a first improvement in the return they get for cash in the bank. When that happens, their reaction will also be: about time too.