The MPC judges that supply and demand in the economy are currently broadly in balance. Potential supply growth has been subdued in recent years and is projected to remain below its historical average rate. As a result, the pace at which output can grow without generating inflationary pressures is likely to remain modest.
Most indicators suggest that the labour market is tight and that supply and demand in the economy overall are currently broadly in balance (Section 3.1). Therefore the rate at which demand can grow sustainably over the next few years will depend on potential supply growth. This, in turn, will depend on growth in labour supply and productivity, both of which are projected to be more subdued than in the decade prior to the crisis (Section 3.2).
The MPC judges that supply and demand in the economy are currently broadly in balance. That judgement is consistent with top-down estimates of the output gap from statistical filters that estimate potential supply using past observations of GDP, inflation and unemployment. It is also corroborated by other indicators of spare capacity. For example, the rate at which those already in employment are switching to new jobs — which will, in part, reflect the degree to which employers are competing to hire employees — is only a little below its pre-crisis rate (Table 3.A). Indicators of underemployment — such as the proportion of part-time workers unable to find a full-time job — have continued to fall back towards their pre-crisis levels. The number of vacancies per person in the labour force is at a record high (Chart 3.1). And survey measures of firms’ recruitment difficulties are around or above their pre-crisis levels. Contacts of the Bank’s Agents report that, for most businesses, the main constraint on increasing output is the availability of labour. Survey measures of capacity utilisation within companies suggest little scope to increase output with existing resources (Chart 3.2).
The unemployment rate was 4.0% in the three months to August (Chart 3.3), in line with the August Report projection and a little below the MPC’s judgement of the equilibrium rate of 4¼%.1 While employment is expected to have risen only a little in Q3 (Table 3.A), it is higher than a year ago. Having fallen in previous quarters, average hours worked appear to have picked up in Q3 to around their level a year ago. Taking employment and average hours together, total hours worked are projected to have risen by 1.1% in the year to 2018 Q3, accounted for entirely by employment growth (Chart 3.4).
The unemployment rate is projected to fall slightly further to 3.9% by the end of the year (Chart 3.3). Most survey measures of employment intentions are around their pre-crisis average levels (Table 3.A), which, together with an elevated vacancy rate (Chart 3.1), suggests that demand for labour remains solid. Beyond the end of the year, the unemployment rate is projected to remain broadly stable, while a margin of excess demand builds (Section 5).
Most indicators suggest a tight labour market
Selected measures of labour demand and labour market tightness
The vacancy rate is at a record high
Vacancies to labour force ratioa
Survey measures suggest there is little spare capacity within companies
Survey indicators of capacity pressuresa
The unemployment rate is projected to fall to 3.9% in Q4
Unemployment rate and Bank staff’s near-term projectiona
Growth in total hours worked is expected to have recovered in Q3
Contributions to four-quarter growth in total hours workeda
The growth in employment over the past few years has absorbed slack in the labour market. Given that, the scope for further sustainable increases in employment is likely to be determined in large part by labour supply growth. Labour supply growth is projected to be subdued relative to recent years, with all of it expected to come 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. The ONS projects net migration to fall somewhat in coming years (Chart 3.5), reducing population growth. In the year to March 2018, net migration to the UK was 270,000, slightly above the ONS projection. Within this, net migration from the EU was around 90,000, having slowed after the UK’s referendum on EU membership in 2016. LFS data suggest that the number of EU nationals in employment in the UK has fallen slightly over the year to 2018 Q2.
There is a risk that net migration could fall more sharply than the gradual decline implied by the ONS projections. There tends to be a positive relationship between migration flows to the United Kingdom and UK economic conditions relative to those in migrants’ home countries.2 Over the coming years, the subdued outlook for UK per capita GDP relative to that of other countries could reduce net migration by more than implied by the ONS projections. In addition, net migration will be affected by any changes to institutional arrangements for the movement of labour, or uncertainty around those arrangements.
With a subdued outlook for labour supply growth, a key driver of potential supply will be developments in labour productivity — the amount of output that can be produced per person, or per hour worked.
Productivity growth in the UK since the crisis has been subdued: for example, the current level of output per hour is only slightly above its pre-crisis peak (Chart 3.6). Compared to other economies, UK productivity growth has been relatively lacklustre, suggesting some role for UK-specific factors. Part of the weakness, however, may have been driven by global factors such as slower growth in world trade — which tends to be associated with productivity growth — and developments in the financial sector, which is increasingly international. Consistent with this, productivity growth in the UK and most other G7 countries tends to be positively correlated and growth has slowed across many of them.
Over half of the productivity growth slowdown in the UK can be accounted for by the manufacturing and finance sectors (Chart 3.7).3 In the manufacturing sector, trends in world trade flows may have been one influence on productivity growth. For example, it is possible that the process of offshoring could have boosted measured productivity growth during the early 2000s. More generally, growth in world trade tends to be associated with productivity gains through greater economies of scale, increased competition and exposure to international flows of new ideas. As manufacturing firms tend to be highly integrated within global supply chains, their productivity growth is likely to have been affected by the weakness in trade growth since the crisis, as well as the weakness in productivity growth in other countries.
In the financial services sector, rapid growth in leverage in the pre-crisis period is likely to have boosted productivity growth. The subsequent slowdown is likely, in part, to reflect that effect unwinding. Mismeasurement of financial services output may have played a role in overemphasising the effects of rising leverage prior to the crisis on productivity growth and equally the effects of the deleveraging since.
A role for global factors is consistent with the behaviour of productivity growth at the level of individual companies. These data suggest that aggregate productivity growth tends to be driven by growth in larger, more productive companies, many of which tend to be exporters. At least in part, the weakness of productivity growth over the past decade appears to reflect the fact that the most productive firms are not becoming more productive at the same rate as they used to. This may reflect the effect on large UK exporters of the slowdown in trade and productivity growth across countries since the crisis.
Growth in labour productivity can be accounted for in terms of the amount of capital utilised as well as the efficiency with which available resources — capital and labour — are used to produce output. Such an approach suggests that the weakness in UK productivity growth since the crisis is in part due to slower growth in capital per hour worked (Chart 3.8), which in turn partly reflects weak investment. But the weakness in productivity growth appears to also reflect slower growth in the efficiency with which inputs are used. Previous Bank analysis has suggested that this, in turn, may in part reflect the misallocation of capital across both companies and sectors.4
Overall, the MPC assumes that productivity growth rises somewhat over the forecast period, to around 1% (Section 5). There are, however, risks around that projection in both directions. For example, it is possible that recent advances in technology will increase productivity growth to above the current projection.5 But the benefits of past advances in technology were experienced over many years, and required a period of adjustment when measured productivity growth was lower, so an imminent marked boost to productivity growth from this source is unlikely.
Average annual productivity growth of 1% is subdued relative to its historical average of around 2%. In part, this is because some of the factors weighing on growth since the crisis are projected to persist. In addition, the outlook for productivity growth is likely to be affected by changes in trading arrangements as a result of Brexit, even under the assumption of a smooth adjustment to those new trading arrangements (Box 4). A reduction or reorientation of trade and supply chains, for example, is likely to weigh on productivity growth for a period.6
Net migration is projected to fall from current levels
Decomposition of net inward migration by citizenshipa
UK productivity growth has underperformed relative to most of the G7
Hourly labour productivity in the G7a
Finance and manufacturing account for over half of the post-crisis weakness in productivity growth
Contributions to hourly labour productivity growtha
Part of the weakness in productivity growth can be attributed to lower investment
Contributions to four-quarter growth in whole-economy hourly labour productivitya
Monitoring the MPC’s key judgements