12 September 2023
The further easing in the labour market (the unemployment rate has risen to 4.3%) is good news for the Monetary Policy Committee (MPC). However, with private sector pay growth exc. bonuses still exceptionally high, at 8.1%, the MPC will only be able to take limited joy from the employment data. Wage growth is too strong for the MPC to relax just yet, which suggests the MPC will opt for one more 25 basis points (bps) hike at its meeting next week.
Labour market weakening
There are clear signs that the labour market is starting to ease. An extra 159,000 people became unemployed in the three months to July, compared to the three months to April, while there was a drop in employment of 207,000. As a result, the unemployment rate rose from 3.8% to 4.3%.
What’s more, there was a further fall in the number of job vacancies. The three-month average fell from 1.017m in July to 0.989m in August. That’s the first time it’s fallen below 1m since July 2021. The number of employees on payrolls also fell marginally by 1,000 in August, but this was well below consensus expectations for a 30,000 increase. In addition, the three-month average vacancy-to-unemployment ratio—commonly referenced by the MPC as the best indicator of labour market tightness—declined to 0.71 in July, from 0.72 in June and a peak of 1.05 in August 2022. It is now almost back to its average level in 2019, 0.63.
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 8.1%, only fractionally down from 8.2% in the previous month, but it is still well above the Bank’s prediction for it to fall to 6.9% in September. While that is good for workers, total real earnings rose by 1.2%, the fastest growth since late 2021. The scale of the rise suggests underlying pay growth is still far higher than is consistent with 2% inflation, which the MPC consider to be around 3.5%. Indeed, the RSM UK Middle Market Business Index showed that 55% of firms increased pay in Q3, up from 45% in Q2 and 72% expect to increase pay over the next six months.
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 next week. The bigger question is whether this will be the last in the cycle. In recent weeks, some members of the Monetary Policy Committee have suggested that it might be.
Chief Economist Huw Pill triggered a dovish reaction from markets when he publicly endorsed a “Table Mountain” path for interest rates, while Governor Andrew Bailey stated the central bank was “near the top of the cycle”. However, Catherine Mann recently said it was too early to pause, so there does seem to be a lack of consensus within the committee.
The labour market is clearly cooling and that will lead to lower pay growth over the next few months. We think that by the time the next MPC meeting comes around in November pay growth will have slowed by enough to allow the MPC to pause then, meaning that rates will peak at 5.5%.