Royal Bank of Scotland : Economics Weekly - Balance of risks

it was more good news for the UK labour market. First, there were 736k more people in employment than one year ago, with 80% of that rise coming from additions to full time employment. Second, the number of people unemployed dipped below the two million mark and the rate dropped to 6% - within one percentage point of its average between 2000 and 2007 and 1.7% lower than a year ago. The scale of the UK's jobs recovery continues to impress.

The numbers change, but the song remains the same. It is now more than six years since growth in regular pay fell below increases in the cost of living. The latest figures have pushed us a little closer to the promised land of increases in purchasing power, but once again, earnings disappointed. Excluding bonuses, it was only in the manufacturing sector that average earnings growth kept pace with inflation.

UK inflation dropped to just 1.2% in the year to September, a whisker away from the low of 1.1% reached in the depths of the 2009 recession. This compounds the headache for monetary policy makers. With unemployment falling as far and as fast as it has the MPC's estimates of slack in the economy are falling. But this stands in contrast to the failure of pay to outpace inflation. Add falling inflation into the mix and the MPC will be even less keen to raise interest rates as price growth heads further away from the 2% target. Two speeches this week gave MPC members the opportunity to explain their thinking…

One has voted to increase Bank Rate the other, to keep it where it is. This week, Martin Weale and Andy Haldane spoke in defence of their actions. For Weale, the crucial issue is how to make policy when you are uncertain about the future, the data and how the economy works. In this world, it is changes in the data that matter most, so he naturally has been attaching prime importance to falling unemployment. For Haldane, whose speech gave us a "misery index" an "ecstasy index" and an "agony index", the future is one of extremes - either the sun is shining brightly or it is raining. In his view, recent global developments have raised the risk that the UK weather is about to take a big turn for the worse, so now is the time to keep rates lower for longer.

Eurozone GDP growth ground to a halt in Q2, so there is intense focus on whether the slide towards recession can be averted in Q3. The evidence from the latest industrial production data is pointing in the wrong direction though. Output in August was 1.9% lower than last year and 1.4% down on the Q2 average. The industries covered in this data only account for a fifth of all Eurozone GDP, so the end result is far from certain. But a particularly disappointing performance from Germany (-4.3% y/y for August) adds to fears that growth is struggling even in countries that were previously growing.

The Eurozone continues to flirt with deflation. Consumer prices rose by just 0.4%y/y in France during September. Germany is little better with prices rising just 0.8%y/y. Prices are now falling in Spain and Italy, but at this stage the falls are mild at just -0.3% in Spain and -0.1% in Italy. High levels of unemployment and associated weak demand are to blame. With inflation so far from the European Central Bank's target of "below, but close to 2%" pressure will remain for further action from the central bank.

China is still managing to keep new credit growth controlled, or certainly relative to its recent past. New credit over the past four months is around 10% less than the corresponding period last year. It means that the stock of credit is growing at around 16%y/y, which is the lowest pace since early 2006. The authorities are showing restraint for now. The question is whether they can continue to do so as growth slows further.

After a summer of calm financial markets woke up with a start last week. There were big falls on the stock exchanges around the world as markets grew more pessimistic about global growth. The pain was felt in commodity prices too, with oil now down to $85 a barrel. Weaker growth forecasts translated into delaying the expected date that interest rates start rising around the world. In response yields on bonds in the UK, US and Germany fell sharply. But not everyone moved in the same direction. Government borrowing costs spiked in Spain, Italy, Portugal and Greece. A lack of growth is a big threat to the credit-worthiness of these countries, something investors have started worrying about again.