Labour market shows little sign of cooling quickly, another rate hike nailed on

13 June 2023

Strong demand for labour in April, combined with a big jump in average private sector wage growth, suggests the labour market is still far too hot for the Monetary Policy Committee (MPC) to declare its job done. This means a 25 basis points (bps) rate hike next week is a sure bet, and raises the chances of another hike in August. A terminal rate of at least 5% now looks likely. But UK employment is finally back above its pre-pandemic level, which bodes well for economic growth in the second half of the year.

Labour force rebounding

Employment rose by a whopping 250,000 in the three months to April, its largest jump in almost a year, signalling that demand for labour is still extremely strong. This means that UK employment is now back above its pre-pandemic level for the first time. However, much of the extra demand for labour is being matched by a rebound in supply.

The 140,000 drop in inactivity combined with a 45,000 increase in the working age population meant that the 250,000 increase in employment only pulled the unemployment rate down to 3.8% from 3.9% in March.

The drop in inactivity numbers also looked healthier, having been driven by fewer people looking after family and a drop in retirees, rather students picking up a bit of part-time work. More concerning is that the number of people dropping out of the workforce because they are sick is still increasing.

Pay growth still far too high for the MPC

However, the pay data came in far stronger than expected. Private sector average pay growth excluding bonuses came in at 7.6% and the single month figure jumped to 7.9%. What’s more, public sector pay growth is rising quickly. A lot of this will be due to the jump in minimum pay levels in April, which is a one-off increase in the pay level that doesn’t reflect underlying trends. But the scale of the rise suggests underlying pay growth is still far higher than is consistent with 2% inflation.

Particularly alarming for the Bank of England (BoE) will be the pick-up in pay growth on a single-month basis, which rose to an annualised 9.1% in April. The jump means wage gains are running above the central bank’s May forecast — the BoE’s most recent projection saw private sector pay growth of 6.3% in the second quarter of 2023.

Policy conclusions

The forward guidance the BoE issued alongside its May forecast suggests policymakers will tighten more if the data — in particular services inflation and private sector pay — surprise to the upside. And that is exactly what appears to be happening.

Indeed, today’s data suggests the labour market is not easing quickly enough for the MPC to be comfortable – that points to another 25b bps rate hike in June, and raises the chances of a 50 bps hike (although that is not our base case). We expect rate hikes in June and August to take interest rates to 5% before the MPC pauses. If the labour market remains stubbornly tight, interest rates might have to go even higher. But without solving the growing structural problems related to sickness, the UK will continue to underperform.