11 July 2023
The fact that we can now say the labour market data is sending mixed signals, rather than just pointing to unrelenting tightness, is a positive for the Monetary Policy Committee (MPC). Labour supply is recovering quickly and there are signs that demand is starting to ease. But, with private sector pay growth exc. and bonuses still rising, the MPC will only be able to take limited joy from the employment data. That leaves the decision as to whether to hike by 25 basis points (bps) or 50 bps at the next MPC meeting on 3 August finely balanced, the deciding data point may well be next week’s inflation numbers.
Labour force improving
There are now clear signs that the labour market is starting to ease. A large 141,000 drop in inactivity, due to fewer retirees and people looking after family, combined with a jump in the working age population meant that the unemployment rate rose from 3.8% to 4.0% despite an extra 102,000 people being employed.
What’s more, there was a further fall in the number of job vacancies. The three-month average declined further in June, from 1.057 million in May to 1.034 million. As a result, the vacancies-to-unemployment ratio—commonly referenced by the MPC as the best indicator of labour market tightness—declined to 0.77 in May, from 0.83 in April, and a peak of 1.05 in August 2022. It will reach 2019’s average level by November, if the rate of decline since its peak is maintained.
But pay growth still far too high
However, that rise in the unemployment rate has yet to translate into slowing pay growth. Private sector average pay growth excluding bonuses came in at 7.7%, up from 7.6% in the previous month. The scale of the rise suggests underlying pay growth is still far higher than is consistent with 2% inflation.
That’s largely to be expected, it has always taken a little time for changes in labour market slack to influence wage growth. Forward-looking surveys all point to pay growth easing over the rest of the year and if the labour supply continues to ease, that should eventually feed through into slower wage growth.
Overall, today’s data suggests that while the labour market is now easing, it’s not loosening quickly enough for the MPC to be comfortable – and that points to another 25 bps rate hike in August. It also leaves the door open to another 50 bps hike, much will depend on whether next week’s inflation data continues its hot streak. If the labour market remains stubbornly tight, interest rates might have to go even higher, financial markets are pricing in a peak rate of around 6.5%. But without solving the growing structural problems related to sickness, the UK will continue to underperform.