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A surge in people leaving the British workforce due to ill health or early retirement could force the Bank of England to raise interest rates further, its chief economist has warned.
With the departure of more than half a million workers from the job market due to the Covid pandemic risking inflationary pressures, shocks from higher energy prices are likely to be dampened, Hugh Pill said.
In a speech to business leaders in London, he suggested a rise in economic inactivity – when working-age adults are not employed or looking for one – could force a response from Threadneedle Street.
“Increasing inactivity among the working-age population represents an adverse supply shock, adding to the difficult short-term trade-offs facing monetary policy,” he said.
Peel said the workforce exodus could force employers to offer higher wages, amid near-record job vacancies and the lowest level of unemployment since the 1970s. This, in turn, could fuel inflation if firms raise their prices to accommodate the higher wage bill.
“The labor market has continued to tighten and has proven to be tighter than we expected, largely due to adverse developments in participation that we did not fully anticipate,” he said.
The UK lags behind other advanced economies where employment is still below pre-Covid pandemic levels. Official figures show that the number of people classified as economically inactive has risen by around 630,000, driven by record levels of long-term illness and a rise in early retirement.
Economists, including Peel’s predecessor Andy Haldane, have warned that Britain’s “missing” workforce is contributing to a weaker post-pandemic recovery in the UK than in other nations, while questioning whether the NHS backlog and years of underinvestment in the health service may have played a role.
Despite sounding the alarm over persistently high inflation, Peel said there were some signs the labor market was starting to “curve” as the economy slid into recession, including a stabilization of job vacancies from historically high levels.
“It will weigh against domestic inflationary pressures and ease the persistent inflationary risk,” he said.
He also said rates would not need to rise to the levels set by financial markets before the central bank’s last decision on borrowing costs – which would have pushed rates to around 5.25% at the end of next year.
The bank earlier this month raised rates by 0.75 percentage points to 3%, despite predicting that higher borrowing costs would push the economy into its longest recession since the 1930s.
However, Peel warned that “there is still much to do” to raise interest rates to rein in inflation above 11% for the first time since 1981, with the aim of preventing higher rates from spiraling.
“Further steps are needed to ensure that inflation returns steadily to its 2% target over the medium term,” he said.
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