Earnings and jobs data add to pressure on interest rates

AN UNEXPECTED drop in unemployment and surge in average earnings dealt a blow yesterday to hopes that low inflation would persuade the Monetary Policy Committee to hold interest rates unchanged.

AN UNEXPECTED drop in unemployment and surge in average earnings dealt a blow yesterday to hopes that low inflation would persuade the Monetary Policy Committee to hold interest rates unchanged.

"Inflation is anything but alive and kicking on the high street," said Richard Reid, chief economist at Donaldson, Lufkin & Jenrette. But he still predicted a quarter-point increase in rates next month.

Other analysts thought the tight jobs market might even tip the balance in favour of a half-point rate rise. "November may be seen as the last clear opportunity to hike for a few months," said Ken Wattret at Paribas.

Recent figures have painted a clear picture of a strong recovery in growth, with the housing market verging on a boom and joblessness still on a downward trend. However, opinions are sharply divided on the implications for inflation.

Optimists - including some members of the MPC - predict inflation will remain low for some time. The strong pound, in particular, has been keeping high street prices subdued. The pick-up in earnings growth has weakened the optimistic case.

Yesterday's figures showed unemployment fell on both the claimant count measure, down 5,400 to 1.2 million in September, and the Labour Force Survey measure, down 83,000 to 1.71 million in the three months to August. Falling employment in manufacturing was more than offset by gains in services, and total employment rose to a new record of 74.1 per cent of the working age population. The economy generated 99,000 new jobs over the summer months.

Most economists agreed that the Government's New Deal has contributed to the drop in joblessness, which has extended to all regions. The Department for Education and Employment said the New Deal had put 135,000 long-term unemployed young people into jobs and another 87,000 into training or work experience.

However, the continuing decline in unemployment led to unwelcome pay pressures. The headline growth in average earnings jumped to 4.9 per cent in August, up from 4.6 per cent in July, bringing a stern warning on the need for pay restraint from Chancellor Gordon Brown.

The pick-up was driven by private sector services, where pay growth climbed to 5.4 per cent in August, compared with 5 per cent the previous month. Basic pay rather than bonuses accounted for the increase, and the Office for National Statistics said a change in the sample of businesses to include more service sector companies had not affected the figures.

Pay growth even edged up in industry, from 3.5 per cent to 3.6 per cent. But earnings slowed in the public sector from 4.6 per cent to 4.3 per cent.

The figures set alarm bells ringing in Whitehall. Tessa Jowell, the Employment Minister, said: "Responsibility in wage bargaining across the public and private sectors is essential for stability and steady growth."

The figures brought claims from industry that there was no dangerous build-up of pay pressures. The Engineering Employers' Federation (EEF) said the average pay settlement among its member firms had fallen to just 2.4 per cent in the three months to September. "Any tightening of the labour market is not creating inflationary pressures in the engineering industry," said David Yeandle of the EEF.

Kate Barker, chief economist at the Confederation of British Industry, said: "The growth in employment is welcome but the sharp increase in earnings growth... does not square with our recent surveys."