The current state of the labour market

After a period of weakness, the labour market appears to be stabilising. Unfortunately, there are still significant questions around the accuracy of the labour market data, making it difficult to gauge its true state. But firms appear to be hiring again. Meanwhile, the recent slowing in wage growth is likely to continue next year as much lower inflation is factored into pay deals and the better availability of labour keeps costs down. Public sector pay deals are unlikely to make much difference to the outlook. However, the biggest challenge is getting more than one million missing employees back to work.

Labour market data as clear as mud

No one really thinks the unemployment rate jumped from 3.8% at the start of the year to 4.4% in April, and then back to 4.1% in July. This volatility probably has a lot to do with the low response rate to the Labour Force Survey (LFS), raising questions about the validity of the official employment statistics. The UK isn’t alone here; the US has also had to make significant revisions to its labour numbers.

Looking at broader measures of the labour market, it seems like the demand for labour is picking up again. The official measure of employment rose by 265,000 in the three months to July, the third consecutive increase. What’s more, survey measures are trending up and redundancy notifications are down on last year. However, the number of people that HMRC estimates are on payrolls dropped by almost 60,000 in August, although this measure is very volatile. Additionally, the number of firms reporting recruitment difficulties has continued to ease. 

The takeaway is that the labour market is probably levelling out.

As economic growth picks up over the next year, hiring should also rebound. But labour supply should continue to improve as high levels of immigration and increasing real wages boost the labour force. Overall, we expect growth in labour supply to be slightly quicker than growth in demand for labour, meaning the unemployment rate may gradually rise from 4.1% currently to 4.5% by the end of 2024. That would still be well within a normal range for the UK and would be about in line with where the Bank of England (BoE) thinks the natural rate is (the natural unemployment rate is where the labour market is in a state of equilibrium). 

However, this relatively benign unemployment picture hides a much more troubling underlying trend. There has been an increase of almost one million in inactivity levels since the pandemic, representing about 3% of the UK workforce just dropping out. Most of these, almost 800,000, are people saying they are now too sick to work. 

This is putting significant pressure on the labour market and has shown no signs of improvement. Unless the new government can make significant progress on getting some of these people back into work, the labour market will remain tighter, wage growth and interest rates will be higher, and the impact on the fiscal position will be worse than it needs to be.

UK wage growth to slow further 

At the same time, wage growth has already slowed and is likely to slow further for two reasons. 

First, lower inflation will start to be factored into pay deals this year. It is much harder to ask for, or to give, big pay rises when inflation is back at 2% without a corresponding increase in productivity, which does not seem forthcoming. 

Second, the increase in the availability of workers and rising unemployment will add to the slowing in wage growth. 

We expect wage growth to slow to around 4% by the second half of next year. However, that would still be relatively high by recent standards. That’s because as long as there are high levels of inactivity, competition for a more limited pool of workers will keep wage growth higher for longer. In addition, strong public sector pay deals will put some upward pressure on headline wage growth, although the impact on total pay will be limited.

Conclusion

We expect hiring to increase as the economy continues to recover over the next year, but this is unlikely to result in a tighter labour market as strong population growth and the recent increase in real earnings will increase the availability of workers. Going forward, we expect pay growth to continue to gradually slow, but it will remain relatively high by historical standards.

For more information, please get in touch with Tom Pugh, Neil Thomas or your usual RSM contact.