14 December 2023
Another sharp slowdown in pay growth in October, from 8.0% to 7.2%, gives further justification to the Monetary Policy Committee’s (MPC) decision to keep interest rates at 5.25% and strongly suggests that the committee is unlikely to make any changes at its next meeting on Thursday.
However, pay growth is still double the 3% - 3.5% that the MPC thinks is consistent with 2% inflation. It will take time to come down to a level the MPC is comfortable with, that’s why we’re not expecting any cuts in interest rates until the second half of next year.
Labour market slowly loosening
The experimental labour market data produced by the ONS, until its new labour force survey is ready, showed that the unemployment rate remained at 4.2%. But vacancies fell for the 17th consecutive month and jobless claims rose by 16,000 suggesting that the labour market continued to slowly loosen.
However, employment barely rose, suggesting that the number of people working in the UK is still below it’s pre-pandemic level in contrast to the euro-zone where employment has risen by almost 3% and the US where it is almost 2% higher. That is a major reason for the underperformance of the UK.
At the same time, private sector wage growth excluding bonuses, the measure most reflective of underlying pay pressures, slowed from 7.9% to 7.3%. Just as importantly for households, real wages grew by 1.4%, the fastest rate since March 2022. That, combined with a big increase in government transfers to low-income households, should give a bit of a boost to consumer spending in the fourth quarter and prevent the economy sliding into recession at the end of the year.
The fall in annual private sector pay gains mostly reflects a softer pace of underlying growth. On a three-month-on-three-month basis, pay pressures dropped to an annualised 3.9% in October, from around 5.8% previously. That’s materially weaker than the pace recorded in the spring.
The policy outlook
The MPC kept rates on hold for a second straight meeting in November. Now that interest rates are in restrictive territory, meaning that they are high enough to have a dampening effect on economic activity and inflation, the Bank sees little need to push them higher.
The latest data showing a further cooling in the labour market and pay growth materially losing momentum support our view that the hiking cycle is over.
However, the level of wage gains is too high for the Bank of England (BoE) to be relaxed about the risk that inflation proves more persistent. And from the central bank’s perspective, the labour market is still adding to inflationary pressures – at the November meeting policymakers revised up their estimate of the equilibrium unemployment rate to 4.5%, meaning that at 4.2% the labour market is still too tight.
As a result, in order to get to 2% within the next two years, the labour market might need to loosen more. For that to happen interest rates will need to remain in restrictive territory for a while yet, which is why rate cuts are unlikely before the second half of 2024.