22 June 2022
The Monetary Policy Committee (MPC) may have the justification it needs to raise rates again at its next meeting on 16 June. The drop in the unemployment rate to 3.7% in March, the lowest figure since 1974, and the rise in pay growth to 7% suggests the labour market is continuing to tighten. Combined with soaring inflation, this could strengthen the MPC’s case for interest rate rises. However, economic growth is likely to slow sharply in the second half of the year and that should give the MPC pause in Q3.
The drop of 118,000 in the number of unemployed people dragged the unemployment rate down from 3.8% in February to 3.7% in March. The number of people in employment rose by 83,000 in the three months to March and the level of vacancies reached 1.3m in the three months to April. That was another record high, so clearly the labour market is red hot. That said, half of the decline in the unemployment rate was driven by a 65,000 rise in the number of ‘inactive’ people (ie those not actively seeking work). There are now 500,000 fewer available workers than there were in February 2020.
This is especially concerning for the MPC for two reasons. First, the lower unemployment rate implies a tighter labour market, and puts upward pressure on wages and inflation. Second, a permanently smaller workforce means the economy can’t produce as much as it once did. This will lead to slower GDP growth and higher inflation.
Admittedly, the cost-of-living crisis will result in much softer economic growth from April, and that will lessen demand for labour and ease some of the tightness in the labour market – but we think the smaller pool of available workers will keep the labour market tight for the next couple of years, at least.
Real pay will fall further
The tightness in the labour market was reflected in a rise in pay growth from 5.4% in February to 7% in March. This was, admittedly, driven by a huge 30.1% jump in bonus payments in the three months to March, but firms have reportedly been paying higher bonuses to keep staff – and it makes little difference to the economy if wages are paid as bonuses or regular pay.
The upshot is that pay growth of 7% is more than double its pre-pandemic level of about 3% and will likely make the MPC even more concerned that the recent burst of high inflation is starting to be reflected in wages. Indeed, we expect the MPC to use the strength in pay growth as its main justification for raising interest rates next month.
Real total pay growth, which takes inflation into account, grew by a much more muted 1.4%. That suggests the cost-of-living crisis was starting to bite in March, and will only get worse as inflation jumps in April. In fact, if we exclude bonuses then real regular pay dropped by 1.2% y/y in March. Real wages are likely to fall by around 3% in 2022, which would be the deepest squeeze on spending power on record.
The policy takeaway
The labour market will be central to how much tightening the Bank of England delivers this year. A hike in June will make five back-to-back increases, so we expect a pause after that. This reflects the view that the slowdown in the economy will be enough to take some of the heat out of the labour market and wage growth.
Clearly, though, there’s a risk that the job market will continue to tighten. We expect the Bank to continue its rate-hiking cycle in the second half of the year if that happens, but the pace of tightening would likely slow to some degree.