19 July 2022
Labour market Big jump in employment makes a rate hike more
The huge jump in the number of people employed in the three months to May, combined with the tick up in underlying wage growth, significantly raises the chances of the Monetary Policy Committee (MPC) hiking up rates in August.
Admittedly, the rate of year-over-year (y/y) total wage growth fell; from 6.8% in the three months to April, to 6.2% in May as bonus payments dropped. But regular pay growth rose from 4.2% y/y to 4.3% y/y, which is significantly above the level that’s consistent with the MPC’s inflation target. Add in employment growth of almost 300,000 and it paints a picture of a very tight labour market.
Combine this with soaring inflation, which is likely to have reached 9.3% in June, and the surprise upward revisions to the GDP data released last week and it seems a rate hike next month is now more likely than not. Economists and financiers use basis points (bps) as a measure of interest rates and other percentages, and all the signs are pointing to a rise from the MPC of 50bps.
Labour participation increasing
Despite a 296,000 rise in employment in the three months to May, the unemployment rate held steady at 3.8%. Around half of the increase in employment was driven by ‘inactive’ people (ie those who hadn’t been looking for work) coming back into the workforce.
This suggests that high inflation and fast wage growth is tempting more people back into employment. In fact, in the three months to May, the level of participation was only 75,000 below what it was in the last quarter of 2019. At the end of the first quarter of 2022, the shortfall was 330,000. But we still think the smaller pool of available workers will keep the labour market tight for at least the next couple of years.
Admittedly, much softer economic growth in the second half of the year, due to the cost-of-living crisis, will dampen demand for labour and ease some of the tightness in the labour market. The RSM UK Middle Market Business Index showed a sharp drop in the proportion of firms planning to increase hiring and pay over the next six months.
Real pay will fall further
The tightness in the labour market was reflected in pay growth (excluding bonuses) rising to 4.3% in the three months to May. Bear in mind, though, that total pay is really what matters for businesses and the economy, and a drop in bonus payments meant total pay fell from 6.8% to 6.2%.
That is still well above its pre-pandemic level of about 3%, however, and will likely make the MPC even more concerned that the recent burst of high inflation is starting to be reflected in wages. Even so, real total pay growth, which takes inflation into account, fell by 0.9%, indicating that the cost-of-living crisis took a bigger toll in April. 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. The Monetary Policy Committee’s chief concern in recent months has been high realised inflation and a tight jobs market combining to lift expectations of future wage and price gains. That would make inflation far more persistent. As such, it’s unlikely that the MPC will ease off the brakes until it sees signs that the labour market is losing heat.
The labour market remains very tight by historical standards. Given that, we think monetary tightening still has further to run. Our base case is for the policy rate to rise by 50bps at the next meeting, followed by a series of 25bps rises to reach 2.5% by this time next year. At that point, the MPC is likely to pause as the soft demand outlook deals a more material hit to hiring, labour supply recovers somewhat, and the outlook for inflation becomes more benign.