Published on 10 May 2018
Published on 10 May 2018
Labour demand growth remains robust and a very limited degree of slack is left in the economy. Productivity growth is projected to rise from its recent weak pace, but to remain well below pre-crisis rates. As a result, the pace at which output can grow without generating inflationary pressures is likely to be modest.
The outlook for GDP depends on the evolution of demand (Section 2) and potential supply growth. Supply, in turn, depends on the supply of labour and how productively that labour can be employed. The MPC conducted its annual reassessment of supply-side conditions ahead of the February Report. This section considers the latest data in the context of that assessment.
The balance between demand and supply — that is, the degree of slack or excess demand in both the labour market and the wider economy — is an important determinant of wage growth and broader inflationary pressures. During the financial crisis, output fell, unemployment rose substantially and a significant degree of slack opened up (Chart 3.1). In the years following the crisis, demand could therefore grow more quickly than supply as spare capacity was absorbed. The unemployment rate, for example, fell from 8.5% in 2011 to 4.2% in the three months to February 2018. Although output growth was weaker than expected in Q1, that is likely in large part to have reflected temporary disruption due to adverse weather (Section 2), which is unlikely to have had any significant effect on spare capacity. Overall, a very limited degree of slack is judged likely to remain (Section 3.1).
Productivity growth has been persistently weak since the crisis (Section 3.2). Overall potential supply growth is therefore judged to have been lower than in the past, despite a boost from greater labour supply (Chart 3.1). Part of that boost reflected relatively strong population growth. Population growth has slowed and is projected to remain lower than in recent years. While potential productivity growth is projected to rise slightly, the speed limit of the economy is expected to remain modest relative to pre-crisis norms (Section 5).
Despite a projected rise in potential productivity growth, the MPC expects supply growth to remain subdued
Decomposition of estimated potential output growth(a)
As slack has been absorbed, growth in total hours worked has slowed. But its precise path has been affected by volatility in participation and average hours worked (Chart 3.2). Both fell sharply during 2017 H2 and, while the drop in participation has unwound, average hours worked remain lower than a year ago.
Looking through recent volatility, employment has grown faster than expected at the time of the February 2017 Report, even as output has grown broadly in line with expectations (see Box 5). Indicators of employment intentions have been stable, with most at levels above past averages. And the number of vacancies relative to the size of the labour force has continued to rise (Table 3.A).
That stronger-than-expected employment growth has been partly reflected in a larger-than-expected fall in the unemployment rate over the past year. Wage growth was nevertheless weaker than expected over that period and, partly as a result, the MPC revised down its estimate of the equilibrium unemployment rate to 4¼% in February. There are a number of factors that may have reduced the equilibrium rate in recent years. Those include rises in the average age and educational attainment of the workforce, which have tended to be associated with lower unemployment rates. Increased flexibility within the labour market is also likely to have reduced flows from employment to unemployment and hence the equilibrium rate of unemployment.1
The unemployment rate is projected to fall further to 4.1% in 2018 Q2 (Chart 3.3), a little below the February projection and its assumed equilibrium level. That is consistent with other signs that the labour market is tight. Along with the rise in vacancies, survey indicators suggest that recruitment difficulties are somewhat elevated (Table 3.A) . And, having fallen during the crisis, job-to-job flows have gradually returned to pre-crisis rates (Section 4).
The MPC also continues to judge that there is no material spare capacity among those not actively looking for a job. The 'marginal attachment' ratio — the proportion of the population who report that they would like a job but are not currently seeking one — has fallen sharply in recent years (Chart 3.4). That suggests little scope for the participation rate to rise and it is projected to be broadly flat, reflecting two offsetting factors. The rising average age of the population is likely to weigh on aggregate labour force participation because the participation rate of older people tends to be lower. But participation rates among older people have increased steadily in recent years and this trend is expected to continue.
There are some signs of underemployment, and therefore scope for a cyclical boost to output through increases in average hours worked. Average hours worked in 2017 Q4 were below the hours that households said they would like to work, although by much less than a few years ago. The proportion of those working part-time who would prefer a full-time job is also still some way above its pre-crisis level, despite falling as the proportion of workers in full-time jobs has increased (Chart 3.5). But any scope for average hours to rise as that spare capacity is absorbed is expected to be broadly offset by a structural downward trend in average hours worked. That trend is partly due to an ageing workforce, as older workers typically want to work fewer hours.2
With little slack in the labour market, growth in the size of the workforce will come mainly from population growth. The MPC's forecasts assume that the population evolves in line with the ONS's latest principal population projection, published in October 2017. Under that projection, population growth remains slower than in recent years, reducing the contribution from annual population growth to labour supply by 0.2 percentage points to 0.5%.
A key influence on population growth is net migration to the UK. Net migration rose slightly to 244,000 in the year to 2017 Q3, bringing it back in line with the ONS's projection (Chart 3.6). The level remains around 90,000 below net migration in the year to 2016 Q2, however. Within that, net migration from non-EU countries has risen a little, but EU net migration — which tends to be disproportionately for work-related reasons — has fallen.
The ONS projects net migration to fall somewhat further in coming years (Chart 3.6), reducing population growth slightly. That path is uncertain, however, and there is a risk that net migration could fall more sharply. The extent to which it does will depend on a number of factors including the UK's relative economic performance. Bank staff analysis suggests that the subdued outlook for UK GDP per capita, combined with stronger growth prospects in other countries (Section 1), would, on its own, reduce net migration by a little more than implied by the ONS projection over the next three years.3
Growth in total hours worked has slowed
Contributions to four-quarter growth in total hours worked(a)
Employment intentions remain robust
Changes in employment, vacancies, redundancies and survey indicators of employment intentions and recruitment difficulties
The unemployment rate is projected to fall further to 4.1% in Q2
Unemployment rate and Bank staff's near-term projection(a)
The proportion of people not currently looking for work, but who would like a job, is low
Marginal attachment ratio(a)
Involuntary part-time work remains slightly elevated
People working part-time, as a proportion of total employment(a)
Net migration is projected to fall slightly further in the ONS's projection
Decomposition of net inward migration by nationality(a)
The sharp fall in hours worked during 2017 H2 provided a temporary boost to hourly productivity growth over that period (Chart 3.7). Average hours worked can be volatile from one quarter to another, however. Abstracting from that, growth in output per worker — which tends to be more stable — has continued to be weak, and is expected to have been 0.5% in the year to 2018 Q1. On both measures, productivity growth remains some way short of its pre-crisis average.
A standard growth-accounting framework suggests that around half of the weakness in productivity growth since 2010 has been associated with slow growth in the amount of capital per worker — the resources and equipment available to produce output. In turn, that reflects subdued business investment over much of that period (Section 2). Given this, a recovery in productivity growth is in part likely to be reliant on a pickup in business investment growth.
The remainder of the weakness in productivity growth is accounted for by weak growth in the efficiency with which labour and capital are put to use, known as total factor productivity. The shortfall appears to have been focused within a few sectors, including financial and insurance services and manufacturing.4 That might suggest sector-specific factors have been important, for example the role of higher financial sector leverage prior to the crisis and the deleveraging since then. Equally, broader trends may have disproportionately affected some sectors. For example, growth in world trade tends to be associated with productivity gains through greater economies of scale and increased competition, and so productivity within the manufacturing sector — which tends to be highly integrated within global supply chains — is likely to have been affected by the weakness in trade growth following the crisis.
As well as these pre-existing trends, the outlook for productivity growth is likely to be affected by changes in trading arrangements as a result of Brexit.5 The anticipation of, and uncertainty around, those arrangements has been weighing on business investment (Section 2), and consequently growth in the capital stock.
Overall, the MPC judges that growth in output per worker is likely to pick up slightly in coming quarters, in part reflecting the past pickup in business investment (Section 2). Four-quarter growth in hourly productivity is expected to be volatile during 2018, however, as the boost from the past fall in hours worked unwinds and the recent weather-related disruption distorts headline GDP growth to some extent (see Box 3). More generally, potential productivity growth is expected to remain subdued relative to pre-crisis norms, as the effect of Brexit and other factors weighing on it since the crisis persist (Section 5).
1. For further discussion see Box 4 of the February 2018 Inflation Report.
2. For further discussion see the box on pages 22–23 of the February 2016 Inflation Report.
3. For further discussion see Box 5 of the February 2018 Inflation Report.
4. For more details see Tenreyro, S (2018), 'The fall in productivity growth: causes and implications'
5. For more details see Carney, M (2017), '[De]Globalisation and inflation'.
Productivity growth remains subdued
Measures of labour productivity(a)
Monitoring the MPC's key judgements