14 June 2022
The tick up in the unemployment rate and slowdown in total weekly earnings could be the first signs that the weakening economy is starting to feed through into a softer labour market.
However, the jobs market remains extremely tight and, at 6.8%, wage growth is still far above the level that the Monetary Policy Committee (MPC) views as consistent with its inflation target. Combined with soaring inflation, this will be enough to convince a majority of its members to vote for a further rate hike of 25 basis points (bps) at the next meeting on Thursday. At least three MPC members are likely to vote for a larger rise.
Even so, we doubt a majority of MPC members will be convinced a rise of 50bps is necessary – the economy has contracted for two consecutive months, there are signs that the labour market stabilised in April, and the economic outlook is weak.
The 41,000 rise in the number of unemployed people, which drove up in the unemployment rate from 3.7% in March to 3.8% in April, suggests that the labour market has started to stabilise. But a further 177,000 rise in the number of people employed and the drop of 39,000 in the number of inactive people suggests the rise in the unemployment rate is because more people are coming back into the workforce, rather than because of a drop in demand for labour. Indeed, the number of vacancies rose to a new record of 1.3m.
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.
We still think the smaller pool of available workers will keep the labour market tight for at least the next couple of years. Indeed, the strength in labour demand is running against a backdrop of constrained supply. Participation increased by a quarterly rate of 130,000 in the three months to April, but remains significantly lower than its fourth quarter 2019 average – by around 217,000. This supply-demand mismatch is likely to take some time to unwind, keeping the jobs market tight.
Real pay will fall further
The tightness in the labour market was reflected in pay growth, excluding bonuses, staying at 4.2% in the three months to April. 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 7% to 6.8%.
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. Indeed, the MPC will probably use the strength in pay growth as the main justification for raising interest rates again on Thursday. However, real total pay growth, which takes inflation into account, grew by a much more muted 0.4%, suggesting 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, we’re sceptical the MPC will ease off the brakes until it sees signs the labour market is losing heat.
Even with the slight rise in the jobless rate seen in today’s data, 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 25 bps at every meeting between now and November, until it reaches 2%. 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.