The economic surprises of 2013 were the strength of growth from the spring and the speed of the decline in unemployment later in the year. Both had been suggested by a monetarist forecasting approach*. Better news has contributed to the consensus GDP growth projection for 2014 moving up to 2.8%**, close to the expectation here of “about 3%” based on monetary trends.

The next surprise could be a strong pick-up in wage and price pressures in late 2014 and 2015. This would fit with a two-year lead from money growth to inflation, as well as evidence that the economy is now operating above non-inflationary “potential”. The vacancy and short-term unemployment rates***, in particular, have moved through longer-term averages, indicating that labour market conditions are tight by historical standards. Real earnings growth is inversely correlated with the short-term jobless rate; it is much less sensitive to longer-term unemployment – see first two charts below.

Rising wage risks are confirmed by today’s Recruitment and Employment Confederation (REC) jobs report, showing that candidate availability is falling at the fastest pace for 10 years, with corresponding strong upward pressure on starting salaries for new permanent recruits. The final chart is taken from a recent speech by MPC member Ian McCafferty; the REC permanent salaries index climbed further last month and is close to the highs reached in 1998 and 2007. Whole-economy earnings growth is forecast here to rise to about 4% by the May 2015 election, contributing to the Conservatives moving into a poll lead versus Labour – see previous post.

*See, for example, here and here.
**Treasury survey of forecasters, April 2014.
***Short-term = unemployed for up to six months.