UK economy output '16% below trend'


Speculation over interest rate rise

Productivity in the UK economy remains 16% below where it should be despite the recovery, the Bank of England has said.

The key measure could have an important influence on the path of future interest rates while its weakness has been described by the International Monetary Fund (IMF) as a major risk to growth.

Officials are puzzled by the weakness, with a series of possible explanations - such as firms holding on to workers during the downturn and a drop in investment over the same period - not enough to explain the discrepancy.

It includes large shortfalls in measures such as output per hour or output per worker.

Measures of productivity are important in determining interest rate policy because they can help estimate the ability of the country to grow without generating too much inflationary pressure.

The Bank of England's quarterly bulletin said productivity was 4% below its pre-crisis peak in 2008 while it remained 16% off where it would have been had pre-crisis trends continued.

It said: "There remains a large degree of uncertainty around any interpretation of the weakness in productivity."

The report said attempted explanations "are unlikely to be exhaustive and are unable to explain the full extent of the productivity shortfall".

It said that since the financial crisis in 2007-8, productivity had been "exceptionally weak" - though there had been modest improvements last year - with performance "considerably weaker than most other advanced economies".

Earlier this month the IMF cited the measure as one of the key risks to the economic outlook, alongside the threat from an overheating housing market.

It said the durability of the recovery hinged on productivity growth, but warned this remained "well below historic norms".

The IMF said accelerating improvement in this would spur investment and output "while allowing real wage increases without triggering inflation" but that if it continued to be flat, growth would eventually stall.

Bank of England policy of targeting a cautious, gradual rise in interest rates assumes a steady pick-up in productivity as the recovery progresses.

But Scotiabank economist Alan Clarke said disappointing figures here may have been one of the reasons why governor Mark Carney last week signalled that rates could rise sooner than expected.

He said: "The MPC [Monetary Policy Committee]'s assumption of accelerating productivity is being continually challenged to breaking point and enough is enough."

One explanation for weak productivity, cited by the Bank's report, was companies retaining staff, despite weak demand, in the expectation of recovery - to avoid the costs of firing and subsequent re-hiring.

This may have been partly helped by wages remaining subdued.

Holding onto resources in this way means firms are not as productive as they might otherwise have been. But such factors are not enough to explain the productivity puzzle fully, the Bank said.

Other reasons might include the disruption to investment caused by the financial crisis, as well as a squeeze on finance from lenders which would have forced companies to operate less efficiently by restricting day-to-day working capital.

Meanwhile, productivity may have been dragged down by the survival of struggling companies as banks offer support if they are struggling with debt.

Also, some firms could have diverted resources towards winning new business - work which would not count in itself as productive.

The Bank said: "None of the individual explanations covered in this article are able to fully explain the extent of the productivity puzzle.

"Rather, it seems likely that all of them, alongside the potential for data mismeasurement and changes to longer-term trends in mining and extraction output, have had a role to play.

"Although the different explanations account for a large part of the measured shortfall, there is a wide margin of uncertainty surrounding each of these factors - and a significant proportion of the puzzle remains unexplained."

The biggest economies in 2020

The biggest economies in 2020