View from City Road: Redundancy fear may help keep inflation low

October's spectacular 49,000 fall in unemployment looks a little too big to be entirely convincing, but it certainly shows that the jobless total is on a sustained downward trend.

The unexpected fall in the annual rate of earnings growth to 3 per cent, meanwhile, shows that the tightening in the labour market has yet to trigger inflationary pressures from pay negotiations. Pay settlements, which normally turn upwards at the same time as earnings growth, are running at around 2.5 per cent and have yet to accelerate.

One explanation is that the fall in unemployment has not been matched to anything like the same degree by a rise in the number of people in work. Employment plunged in the aftermath of sterling's devaluation last year and only appears to have turned up in the second quarter as people used their redundancy pay to set up in business on their own. In the third quarter, companies in manufacturing and energy and water supply have continued to shed jobs. A return to upward pressure on wage inflation may have to wait until employment turns up significantly.

The depressive effect of the fear of redundancy on settlements appears to have more than outweighed pressure in the opposite direction from a shrinkage in the number of unemployment benefit claimants pursuing each vacancy. There are fewer people available to work compared with the same point in the last recovery because the number of school leavers is lower and more are staying in further education.

Earnings growth has fallen much further below the 7.5 per cent floor that ruled through the mid-1980s than most economists have expected. The 1.5 per cent pay norm in the public sector helped and has also influenced settlements in the private sector. Earnings growth should not fall much further but if public sector pay continues to be restrained next year then more good news on unemployment need not lead to a serious resurgence in wage inflation for quite some time.

This does raise the prospect of a genuine change of behaviour in the British economy, damping down the cycles of inflation and deflation. Although the markets are clearly beginning to hope that this promised land is achievable, a cautious investor would wait for a few months for more evidence before betting on it.