GORDON BROWN’s tenure at the Treasury is nearing an end and may soon give way to the Darling decade – or at least it might seem like that – assuming Alistair gets the job.

It will soon be time for my end-of-term assessment of the Brown years and his place in the pantheon of chancellors. In the meantime, a challenge he faces came into sharp focus last week. Politically, immigration is a difficult issue for the incoming prime minister; a YouGov poll for this newspaper last weekend showed that reducing immigration easily topped the list of things people want him to do.

But, as chancellor, Brown has been well aware of the economic benefits of immigration, some of which were set out in the Bank of England’s quarterly inflation report last week. The availability of migrant labour had stopped pay settlements picking up more sharply in response to higher inflation, it said, and the “strong inflows of migrant labour” of recent years were set to “continue to bolster the workforce”.

Immigration has been associated in recent years with a rising level of employment – to record levels – and falling unemployment. Despite the political heat it generates, the availability of migrant workers has allowed the economy to expand for longer, without running up against capacity constraints, than would otherwise have been the case.

Now, however, there are signs of a shift. Four councils – Slough, Westminster, Kensington & Chelsea, and Hammersmith & Fulham, all recipients of a large number of immigrants – took the Office for National Statistics (ONS) to task last week over the quality of its immigration figures. Their intervention came as other ONS figures showed, in contrast to recent years, that Britain has a rising unemployment rate and, on the other side of the coin, a falling rate of employment.

In the past two years, according to the government’s favoured measure of unemployment, based on the Labour Force Survey, the number of people out of work has risen by 283,000 to 1.675m. The unemployment rate has gone up from 4.8% to 5.7%.

Employment has continued to increase, by 305,000 to just under 29m over two years, so one part of the story remains intact. But because the workforce has increased significantly, the employment rate – the proportion of working-age people in jobs – has dropped from 74.9% to 74.3%.

This is not purely as a result of immigration. I would not want to encourage granny or grandad bashing (or indeed any other kind of bashing), but if younger people are finding it tougher in the job market, they should look to the rise in employment among people beyond normal retirement age.

Grey power is exerting itself in the job market; the number of people in work older than 65 (men) or 60 (women) has climbed by 158,000 over the past two years. Inadequate pensions, better health in old age and more job opportunities are lengthening working lives.

This produces the remarkable statistic that less than half of the 305,000 rise in employment of the past two years has been among working-age people. In some younger age groups, employment has dropped.

A 97,000 fall in employment among 16 to 17-year-olds is explicable because more are staying on at school; a 116,000 fall in the number of 25 to 34-year-olds in jobs less so.

But the central facts are that the working-age population has been boosted by immigration, while the overall workforce has increased as a result of older workers. I’ll come on to another big source of labour in recent decades, the higher proportion of women in the job market, in a moment.

On the face of it, rising unemployment is hard to square with an economy that is growing pretty well. The current rate of expansion, 0.7% a quarter, 2.8% a year, is in line with the average of the past 10 years, even though it a little too fast for comfort for some on the Bank of England’s monetary policy committee (MPC).

David Blanchflower, the MPC’s labour-market expert and resident dove, has argued consistently that spare capacity in the job market would hold down the growth of wages, and he has been right; latest figures showed the growth of earnings slowed to 4.5%, even including City bonuses. Excluding bonuses, the rise was 3.7%. But even Blanchflower felt able to sign up to a generally hawkish inflation report from the Bank last week.

Why isn’t a strong economy creating enough jobs to stop unemployment rising? The big reason is growth in the workforce, although public-sector employment – which has accounted for about a quarter of the 2.5m increase in jobs during the Blair years – has also stagnated. It is down on a year ago and flat over two years, even before tougher public-spending limits come in next year.

Will unemployment rise further? The Bank’s aim is to slow the economy to reduce inflationary pressures, which, if successful, will reduce the growth of private-sector jobs. Mervyn King, the Bank’s governor, suggested last week that immigration was likely to respond to the demand for labour here. If the growth in jobs is no longer there, in other words, the supply of migrant labour could dry up.

What if that is not the case? What if the inflow of migrant labour is now permanent?

Not only has unemployment gone up over the past two years but there is evidence of another effect; some people leaving the workforce altogether. The number of “economically active” women – those in work or available for it – has declined over the past year breaking that long upward trend in female participation. We could see more of this.

But the big effect of a slowdown in employment growth, combined with continued, high-level immigration, would be felt in the unemployment figures. Based on recent trends, the favoured unemployment measure could be above 2m and approaching 7% of the workforce by the time of the next general election.

That would mean plenty of spare labour-market capacity, further easing some of the current fears about inflation. But it would also mean an electoral backdrop of rising unemployment, and an obvious political scapegoat – continued high levels of immigration. Brown, a great champion of Britain’s open economy, could find himself losing his own job as a result of it.

PS: In February last year, the Bank of England expected inflation to spend most of 2006 at 2% and stay there in the medium term with a Bank rate of 4.5%. Three months later it thought this would require a 4.75% rate. In August, by which time the rate had risen, the stakes were raised – 5% would be needed, which was duly delivered in November; the Bank then signalling that would be enough.

But no, after the surprise rate rise in January to 5.25%, last February’s inflation report signalled 5.5% would be necessary, as happened 10 days ago. But the story continues. The headline from last week’s inflation report was that Bank rate needs to rise to 5.75% and, based on recent experience, August looks like the most obvious time for it. There’s a pattern here. Over the past year or so the Bank has consistently underestimated both the rise in inflation and the interest-rate response needed.

Where will it all end? If you wanted to get very gloomy, you would look at an analysis like that of Chris Watling of Longview Economics who, having gone through every component of both the consumer and retail prices index, sees the rise in underlying inflationary pressure as having further to run. He predicts a Bank-rate peak of more than 6%. Add in the dog that has not barked for years – a significant weakening of sterling – and things could get very gloomy indeed.

I am holding to the view that what we are seeing is a pass-through of higher energy prices and that the effect will be temporary. Oil prices are firmer than I had hoped (I’ll return to that soon, too) but are no higher than a year ago. Pay pressures are subdued, as discussed above. Inflation will be back to the 2% target over the next few months. If I’m right, it will stay there.

david.smith@sunday-times.co.uk

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