Economic commentary - March 2010: Uncertainty is the only certainty

The UK economy's recovery from recession is now underway, but the outlook for growth (and for pay, jobs and unemployment) is anything but certain, says XpertHR benchmarking editor, Michael Carty.

"Uncertainty is the only certainty there is, and knowing how to live with insecurity is the only security."

Mathematician John Allen Paulos' words of wisdom are directly relevant to the situation facing the UK economy at the moment, as well to UK employers and employees dealing with the ongoing fall-out of the recession.

The strength and sustainability of economic recovery are open to question, in turn undermining hopes of a return to stability for UK workers. At the same time, surging inflation could prove problematic for pay-setters as the busiest part of the pay bargaining year unfolds. And conditions appear to be falling into place for the potential resurgence of some unwelcome characteristics of the 1970s, most notably industrial action and stagflation.

"Slow" recovery in prospect?

For now, though, the UK's emergence from recession is ongoing and appears to be slowly gaining in strength. Latest revised estimates (published on Friday 26 February 2010) on economic growth show that gross domestic product (GDP) rose by 0.3% in the fourth quarter of 2009. This represents an increase of 0.2 percentage points on the original estimate of 0.1%, which was published in January 2010.

But it remains to be seen if even this weak level of recovery is sustained. The economy could yet plunge back into recession. Data on GDP growth for the first quarter of 2010 will be published on Friday 23 April 2010. These will be very closely watched by the Government. The Guardian noted in its 20 February 2010 print edition: that "[b]ad news about the economy could fatally damage Labour mid-election campaign."

"[T]he strength of the recovery is highly uncertain", according to the Bank of England's latest quarterly Inflation Report (PDF format, 3.4MB). It says that while estimates for the UK's weak return to economic growth are "more likely than not [to] be revised up a little over time", the confluence of factors influencing growth going ahead "points to a slow recovery in the levels of economic activity." The most likely outcome for GDP is therefore that "a period of gradual expansion is in prospect."

But things could still go either way. Rather than precise GDP forecasts, the report includes a fanchart setting out the full range of potential outcomes, which include a return to negative growth. Crucially, Bank of England governor Mervyn King refused to discount the possibility of a double-dip recession. King stated:

"Of course this forecast (for GDP growth) is consistent with a possibility of another quarter of negative growth just as it is consistent with several quarters of very rapid growth."

Sunday Times economics editor David Smith notes that the fanchart appears to suggest that GDP is most likely to grow by 1.5% in 2010, rising to 3.5% in 2011, a forecast which is "more optimistic than other forecasters".

One less optimistic forecast comes from the National Institute of Economic and Social Research (NIESR), which expects 1.1% GDP growth in 2010 (PDF format, 43.2K), some 0.4 percentage points below Smith's interpretation of the Bank of England's central projection.

And disappointing readings on most key economic indicators during February 2010 suggest that "the worst downturn in a generation is still not over", according to the Guardian's Heather Stewart. Her colleague Nils Pratley goes still further: "[T]he chances of a double-dip recession would seem to have increased substantially.

Inflation spike continues

Inflation has proven volatile over recent months. The Government and the Bank of England expect this volatility to continue. Chancellor Alistair Darling says "the inflation outlook remains subject to some uncertainty" (PDF format, 768.9K). And the Inflation Report finds prospects for inflation to be "unusually uncertain" with "significant risks to the inflation outlook in either direction."

The latest inflation data show ongoing sharp rises, driven by rising oil prices and the return of VAT to 17.5%:

• RPI inflation rose by 3.7% over the 12 months to January 2010, this is up 1.3 percentage points from 2.4% a month ago, and from -1.4% six months ago (July 2009).
• Consumer prices index (CPI) inflation - the Government's target measure - rose by 3.5% in January 2010, up 0.6 percentage points on the previous month's figure (2.9%). The target rate is 2%.

It appears likely that the spike in inflation is temporary, and that both RPI and CPI will fall back later in the year. But this is not guaranteed.  Howard Archer of IHS Global Insight told the Guardian that elevated inflation could yet persist, saying that " there is obviously the risk that inflation could be stickier than expected and not fall back as much or as quickly as hoped."

However, the Bank of England Inflation Report expects the most likely scenario for inflation to involve further sharp rises, followed by a sharp fall. This fall would come as "downward pressure from the persistent margin of spare capacity" [unemployment, in other words] reasserts itself as the key influence on inflation.

Unemployment lull continues

Latest data confirm that unemployment remains high, yet the headline unemployment rate continues to surprise by refusing to budge from 7.8% for a third consecutive rolling quarter.

Nonetheless, "the UK jobs market is still on the ropes", according to CIPD chief economist John Philpott. Sustaining the boxing metaphor, he says "[u]nfortunately, there are more punishing rounds ahead." Philpott argues that the labour market will suffer as employers are constrained by "ongoing concerns about productivity, wage costs and inflation alongside the spectre of deep public spending cuts." The CIPD says its research suggests that the number of redundancies in the first quarter of 2010 will be almost double that seen in the final quarter of 2009.

NIESR also expects further sharp growth in unemployment: it is "likely that unemployment has just paused and will revert back to an upward trend this year. [...O]ur forecast shows unemployment peaking at above 9% in 2011."

In contrast, the Bank of England Inflation Report, finds further increases in unemployment possible, but by no means certain. The report remarks on "the resilience of employment" during the recession:

"Employment has fallen in this recession, but by much less than the decline in output. [... P]ay moderation may have helped to limit the extent to which companies have reduced employment and hours worked."

Looking ahead, much hinges on the willingness of UK workers to continue to accept ongoing pay restraint. As the report puts it:

"The outlook for employment will also depend on whether employees attempt to resist further restraint in real take-home pay."

Whole economy pay awards collapse back to zero...

Pay restraint would appear to be firmly embedded for now, according to latest data from IRS for XpertHR.

The start of the new decade saw the IRS headline pay award collapse back to zero over the three months to 31 January 2010. Settlements have collapsed back to the record low recorded over the three month periods to July and August 2009. The headline pay award is therefore 3.7 percentage points below the current rate of RPI.

The range of pay awards has narrowed. The lower quartile pay award remains parked at nil, but the upper quartile has fallen by 0.4 percentage points to 1.6%, after holding firm at 2% for the preceding eight rolling quarters.

...with "little scope" for rapid recovery in pay awards

It is clear that the 2010 pay bargaining year has got off to a weak start. Overall, IRS notes that "settlement levels have slackened markedly as we enter one of the busiest periods of the bargaining year."

Other commentators predict a subdued pay outlook for 2010:

• Bank of England governor Mervyn King believes there is "little scope" for pay growth in 2010 and beyond; and
• the Labour Research Department (LRD) predicts a second year of pay freezes for many workers.

The weak prognosis for pay awards is perhaps surprising given the rapid rises in RPI noted above - usually a sure sign that pay award growth will soon follow suit. But these are not usual times. It remains to be seen if 2010 could mark the year in which the relationship between RPI and pay awards is broken.

The CIPD says the spike in inflation comes at the "worst possible time for pay bargaining". CIPD chief economist Dr John Philpott comments:

"There is a risk that higher inflation will trigger bigger wage rises than the UK's ailing economy can currently afford [.... But] real wages will have to be squeezed if jobs are to be preserved and any further rise in unemployment minimised."

It is consequently possible that pay bargaining could represent a faultline in employment relations during 2010.

Back to the 1970s?

As we approach the end of winter 2010, could we see a return to some of the most testing conditions of the 1970s during the coming decade?

Today marks the 39th anniversary of a day of unofficial industrial action on a grand scale: Monday 1 March 1971 saw an estimated 1.5 million UK workers down tools in mass protest at the Industrial Relations Bill (which would ultimately be implemented in August 1971).

This is just one example of the uneasy state of employment relations which persisted throughout much of the 1970s - largely due to the dire economic conditions that plagued the decade - and peaked with the "winter of discontent" in 1978/1979. The overall economic uncertainty that characterised the 1970s was summed up recently by the Daily Telegraph: "If there were any decade over the past fifty years we'd rather forget, then this would be it."

Blasts from the past: industrial action, "oil crunch" and stagflation in store?

On the face of it, while times are hard for many UK workers, employment relations would seem to be plotting a comparatively smooth course.

This can arguably be attributed to the new "collaborative spirit" which emerged over the course of the 2008/2009 recession, with employers and employees working together to minimise job losses by exploring alternatives such as pay restraint and reduced hours. The UK economy has returned to tentative growth, but the economic situation remains precarious, suggesting that the need for this new collaborative spirit could be with us for some time yet.

But the new decade could well see an end to the "benign employment relations of the long Noughties boom", according to the CIPD. It argues that the aftermath of the recession could herald a sea-change in UK employment relations, bringing widespread unrest to workplaces. The coming months and years will see private sector employees deal with the ongoing impact of wage restraint and job insecurity, while their public sector counterparts face the possibility of swingeing cuts to pay and jobs.

Indeed, with pay awards currently trailing RPI inflation by a significant margin, unions may not tolerate subdued pay awards or pay freezes much longer.

TUC deputy general secretary Frances O'Grady asserted that unions are willing to push for higher pay increases in 2010 at her speech to the TUC pay bargaining conference.

David Cameron, meanwhile, has promised a hardline stance on the unions if the Conservatives are returned to power in the 2010 general election. The final possible date for the election is Thursday 3 June 2010, with the actual date for the election appearing likely to fall in May 2010.

As well as the possibility of a flare-up in employment relations later in the new decade, recent weeks have seen warnings of further potential echoes of the 1970s:

• Richard Branson delivered advance warning of a possible mid-decade "oil crunch"; and
• some economic commentators warn that we could see another unwelcome memory of the 1970s to return to plague the UK economy: stagflation.

Focus on stagflation risk

Stagflation - rapidly increasing inflation coupled with weak or declining economic growth and rising unemployment - hit the UK economy hard during the 1970s.

Writing in the Financial Times, Money Week editor Merryn Somerset Webb argues that conditions are ripe for stagflation to return in the near future. As she puts it:

"[W]hile it is easy to dismiss the current UK inflation numbers as a nasty blip, the conditions are in place for a huge jump in prices at some point over the next few years. [...] while it is impossible to say when the focus will actually shift, the main conditions needed for the UK to find itself once again staring stagflation in the face are in place."

The confluence of factors that could result in stagflation include: the ongoing rise in public spending; weak sterling; the rapid rise in manufacturers' input prices (which shot up by 6.9% in December 2009); and the current sharp growth in inflation.

She notes that with the stage effectively set for stagflation, all that is needed is a trigger (similar to the sub-prime mortgage crisis that sparked the credit crunch and dipped the world into recession).

But when and if such a trigger might arise is uncertain.

• Key bargaining statistics on pay, prices and employment for March 2010