Unemployment fell to 7.7% (from 7.8%) in the three months from May to July according to the ONS. That’s great news, but does it mean that mortgage costs are likely to rise earlier than expected?
The Bank of England has said that it doesn’t intend to even think about increasing interest rates until unemployment falls to 7% (unless inflation takes off unexpectedly). It thinks that is likely to take around three years which would mean holding the base rate at 0.5% until some time in 2016.
But the financial markets think that unemployment will fall faster than that and will probably trigger a rate hike sooner, possibly in 2015.
The debate is not academic; expectations that rates will rise sooner than the Bank forecasts are feeding in to the pricing of, among other things, fixed interest mortgages. The interest rate on some fixed interest mortgages have already risen and the earlier and the faster that the markets think rates will rise, the greater that increase will be.
Of course, only time will tell who is right, but it’s worth understanding why the Bank thinks employment will take so long to fall to 7%. The Bank believes that the economy will have to generate 1 million extra jobs to cut unemployment to 7% (you can see why below).
If that is true, there is a long way to go. The ONS reports that unemployment fell by just 24,000 in three months. That equates to around 100,000 new jobs a year. At that rate, it would take a decade to create 1 million new jobs. To shorten that timescale to 3 years requires a sharp acceleration in job creation, so the Bank is not being unduly pessimistic.
Moreover, income growth at just 1% is well below CPI inflation (at 2.8%) which strongly suggests that pay rises will not push inflation higher.
In short, it’s quite possible that base rates will remain lower for longer than the market expects.
Why 1 million extra jobs?
The Bank of England expects that the economy will have to create 1 million new jobs to get unemployment down to 7%.
There are four key reasons why.
Firstly, the economy will have to absorb some of those currently unemployed.
Secondly, it will have to allow for new entrants to the labour market as the population grows.
Thirdly, it will have to cope with a significant number of people who are expected to lose their jobs as the result of government cuts.
Fourthly, it believes that a lot of people currently in work could do a lot more (i.e. increase productivity) before employers need to take on extra staff.