MNI INTERVIEW: BOE To Look At Cutting Potential Growth In Feb

There is a significant risk that the Bank of England will early next year lower its estimate of the rate at which the UK can grow without feeding inflation, after revising down its near-term estimate of equilibrium growth in November, National Institute of Economic and Social Research deputy director and former senior BOE official Stephen Millard told MNI.

A downwards revision could occur once the Bank completes its stock take of the UK economy’s supply side in February, Millard said.

"They might go down, they certainly won't go up. In the next couple of years they have already taken it down," he said, after the Bank in November raised its estimate of the equilibrium unemployment rate (U*) to 4.5% from just above 4%. The increase in U* pushes down aggregate supply growth, which would slow from 1.5% currently to 0.75% next year before rising to around 1.25% in the medium term, the Bank said. (See MNI INTERVIEW:UK With Higher NAIRU More Prone To Wage Pressure)

"They have made an adjustment in terms of what they think is possible for supply growth at the moment, to take it down below that 1.25%. Maybe that is a veiled way of saying we might take that 1.25% down," Millard added.

SUITE OF MODELS

The Bank has in the past distinguished between short- and medium-run equilibrium rates "and it looks like they are doing the same again with the equilibrium rate of supply growth and that makes sense," he said.

Still, the revision higher of U* does not make a downward revision to longer-term trend growth inevitable, he said. Bank economists will use a suite of models to estimate longer-term equilibrium growth, some of which do not rely on U* at all.

"You might think the equilibrium growth rate is determined by technology, the increase in labour supply, the increase in capital stock coming through investment, that these matter much more than the ability of the economy to match up vacancies and workers, which is what really determines the unemployment rate," Millard said.

The shift higher in U* was triggered by upside surprises to wage growth even as unemployment rose above the Bank's previous estimate, with joblessness hitting 4.3% in September.

BACKWARD-LOOKING

It has been clear for some time that U* would have to be revised higher, said Millard, noting that the estimate tends to be backward-looking. BOE Monetary Policy Committee member Jonathan Haskel has already said he thinks the new U* figure may be too low.

"U* itself is a very nebulous concept and it is a lot easier to work out ex-post what it is rather than ex-ante,” Millard said, “We know that unemployment is below U* at the minute because wage inflation is so high ...We at NIESR … thought U* was around about 5% so it is nice to see the Bank revising up towards us.”

An arguably better guide to what has been happening in the UK labour market has been the surge in vacancies post Covid and their subsequent decline, he added.

“There are two margins here, the vacancies margin and the unemployment margin, and if you want to understand how tight the labour market is you really need to look at both. Maybe the mistake was not so much that the Bank had got its estimate of U* wrong, just that it didn't pay enough attention to the vacancy-unemployment ratio," Millard said.