Productivity boost crucial consideration for interest rate hikes, JP Morgan says

Productivity growth will soon gather pace as firms’ confidence builds and they invest in technology and infrastructure rather than labour, according to a leading economist at JP Morgan.

Karen Ward, of the US bank and a former Bank of England economist believes observers have misread the the impact of the global financial crisis on productivity growth.

“The dynamic of this recovery has been peculiar. It’s been very employment rich and very investment light,” she said.

According to Ms Ward, major retailers have cried off implementing a fully automated checkout system because of this effect. Job insecurity had made labour relatively cheap in real terms as workers have not felt confident enough to request pay rises. The cost of automation versus a wage bill which was falling in real terms was therefore unattractive. Such technological underinvestment was widespread.

The political uncertainty of Brexit might be leading to a higher degree of investment caution among UK businesses, globally however, and in the US in particular, investment levels were picking up. The Philadelphia Federal Reserve’s index, which tracks amounts that companies will invest in the next six months has risen to its highest level since 1984. A basket index of other US regions also suggested a strong investment outlook.

Trying to decipher whether or not productivity was likely to improve or not was crucial in the run up to May’s Bank of England interest rate decision, Ms Ward said.

“When you reach full employment you’re at a fork in the road. One option is that productivity picks up, so for a company labour costs stay low, as you’re getting more out of workers. Or, workers start demanding more money from employers, but they are not producing more stuff in return for it,” Ms Ward said.

If the latter course is the case, inflationary pressure could mount sharply, and the Bank of England would need to respond with an interest rate hike. Many observers, including Swiss Bank UBS, expect the Bank to rates interest rates in May.

Productivity levels are also critical for markets. Good labour market data which showed close to full employment and resultant anticipation of wage growth and an uptick in inflation sent markets volatile earlier this year. If productivity were to pick up, inflation might stay relatively low.

Trying to prevent the economy in the UK overheating when employment is at close to record lows is also a problem faced by policy makers at the US Federal Reserve.

Employment is now at levels not seen for nearly 18 years.

Jay Powell, the new chairman of the Fed, has taken a hawkish stance, suggesting that he may increase rates at a faster pace that previously trailed.

On Friday new data showed that pay growth had cooled slightly, despite adding more than 300,000 workers to pay rolls, suggest full employment was not yet reached.

A cool down in pay growth “takes some of the pressure off” stocks, but the labour market continuing to tighten suggests that inflation fears will persist, said James Ingram of MB Capital.

The market expects the Fed to raise interest rates a quarter of a percentage point when it next meets.

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