Some economists believe the central bank is too optimistic about the state of the labour market
The Bank of England believes that unemployment has peaked, with the economy less damaged by the impact of the pandemic than first feared.
Even with the impact of ending the emergency employment support programme, furlough, in September, unemployment will still slowly fall, according to the central bank’s policymakers. This it at odds with the views of some economists, who think that the end of furlough could still cause an uptick in unemployment when it ends this autumn.
The bank signalled on Thursday that it would follow a course of “modest tightening” of monetary policy over the next two years, as the economy starts to grow out of its pandemic-triggered slump. This was a shift in tone from rate setters at the central bank, suggesting the economy had proven more robust in the face of the pandemic than they had earlier expected.
“The profile for unemployment looks very different than envisaged last year, with no spike up as support measures come to an end,” Andrew Bailey, Bank of England governor told reporters at a press conference. “I think this points to the success of economic policy measures in avoiding a marked rise in unemployment in the face of such a large downturn in economic activity,” he added.
Some 1.9 million workers were on the Treasury’s Job Retention Scheme according to HMRC data up to the end of June. This marked a decrease of 590,000 on the previous month. The Bank predicts that unemployment will be at 4.75 per cent by the end of the year, and fall to 4.25 per cent in 2022.
Britain’s economy should grow by 7.25 per cent this year, returning to its pre COVID-19 level by the end of 2021. But then the rate of GDP growth is likely to ease off, and fall in line with the much slower level of expansion seen before the pandemic.
However, some economists think that the Bank’s confidence that unemployment has spiked may be misplaced.
“We’re still in the aftermath of a massive shock,” Tomas Hirst, European credit analyst at CreditSights told The Independent. “We’ve not won the war, we’re in the middle of it.”
There was a risk, Mr Hirst added, that the Bank was underestimating the importance of the ratio of workers to job vaccines. This stands at two to one by his calculation, which considers the number of prime age workers – those not close to retirement – still left on the furlough scheme.
And while some sectors have recovered very rapidly from recession, others are still far from back to normal, economists said, pointing to the British tourism industry in particular.
“I hope that they are right, but I think there’s a risk that unemployment will be higher than the Bank is expecting,” said James Smith, head of macro policy at the Resolution Foundation. “There are particular shortages in particular sectors,” he added. “But bottlenecks are different from overall tightening of the labour market.”
The scarring, a limit on growth caused by damage from lockdowns and supply chain disruptions, was also not as bad as first feared, the Bank said in its monetary policy report. It shifted this from 1.25 percent down to 1 per cent. Both figures are far lower than estimates from the public spending watchdog the Office for Budget Responsibility (OBR).
While the estimates are arrived at independently of one another, a similar positive shift by the OBR could add to the chancellor, Rishi Sunak’s spending power. That’s because it is calculated on the long-term affordability of debt as a proportion of GDP once it has recovered to its pre-pandemic level.
The Bank’s forecast for inflation climbed sharply to 4 per cent by the end of the year, up from a previous estimate of 2.5 per cent. It will stay at that level into 2022, before falling back down to around 2.5 per cent by the middle of next year. That means it will not reach the central bank’s target level until mid-2023.
Still, Mr Bailey dismissed suggestions that the central bank had been overly relaxed about price growth. “We’re not complacent. If things don’t turn out like that then there will be no question that we will have to act,” Mr Bailey said.
The bar for when Threadneedle Street would ease its other stimulus effort, bond-buying – also known as quantitative easing – was lowered. This was previously set to be once the rate of interest set by the central bank reached 1.5 per cent. It will now kick in once that rate reaches 0.5 per cent, much closer to the present rate of interest of 0.1 per cent.
There were “few signs that it is preparing to hike rates soon,” said Ruth Gregory, senior UK economist at Capital Economics. She expects the Bank to raise rates from 0.1 per cent to 0.25 per cent in August 2023, followed by another 25 basis point increase in February 2024, “before shrinking its balance sheet” in mid-2024.
Last month, Michael Saunders, an external member of the central bank’s rate setting committee, said that it might soon be appropriate to “withdraw some of the current monetary stimulus”.
However, overall, the committee voted seven to one to keep buying government bonds at the current level, and to hold interest rates at 0.1 per cent.
Still, the more hawkish shift in tone unsettled some economists. If this process is triggered too early and a cut in monetary stimulus by the Bank is combined with spending cuts by the Treasury, it could seriously dampen the outlook for future growth Mr Smith said.
“The lessons from past crises is that could be a huge mistake,” he said.