Strong pay growth means no MPC rate cut

Growing employment, a stable unemployment rate and strong pay growth means there is virtually no chance of a rate cut from the Bank of England this afternoon. The next interest rate cut will probably come in May as the Bank of England waits to see how the chancellor’s Autumn Budget measures play out in the labour market and if that feeds through to inflation. 

Private sector payrolls point to faster loosening

Despite survey sentiment collapsing in most labour market surveys, there has been no sign of that materialising in the official data. Employment rose by 144,000 in the three months to January and the unemployment rate remained at 4.4% for the third consecutive month. Granted, the official data is unreliable thanks to low response rates to the Labour Force Survey. However other indicators reaffirm the big picture.

Payrolls rose by another 21,000 in February after a 9,000 rise in January. While this means the labour market is doing little more than trending sideways, it’s clear that the labour market is far more stable than some had anticipated. Behind the headline data, private sector payrolls have been stagnant and even falling. It’s public sector payrolls that have propped up labour market, suggesting that the real economy is doing little more than stagnating. 

Labour demand has clearly stabilised after cooling over the last year. Vacancies have been around 815,000–820,000 since November. This picture hasn’t translated to higher unemployment. Redundancies have gradually ticked up to 4.2 per thousand people, but they are nowhere near the 12.2 high of the global financial crisis surveys are hinting at. 

The labour market has clearly weakened, but it is far from collapsing. We still expect the labour market to loosen slightly further as firms adjust to the imminent budget measures, but there are no signs of surging unemployment.

Wage growth remains stubborn

Total pay growth dropped from 6.1% to 5.8% in January. However, this will be of little solace for the Bank of England, which cares far more about regular private sector pay growth. This saw a more modest decline to 6.1% from 6.2%. That’s still roughly double the 3% level typically consistent with 2% inflation. 

However, weaker labour demand should prompt slower wage growth over the year. Workers will find it harder to bargain for large wage increases as a margin of slack opens up in the jobs market. Indeed, underlying momentum in private sector regular pay seems to have pared back a bit on an annualised basis. Data for 3m/3m annualised wage growth dropped sharply from 7.4% to 6%. That should be good news for the Monetary Policy Committee (MPC). 

Public sector pay grew by 5.3% from 4.7%. This is because of more modest gains from October falling out of the comparison window and a big jump in December as new pay deals took effect, pushing the measure up. 

No interest rate cut today

It was always unlikely today’s data would sway the Bank of England to alter its path. 

Stubbornly high pay growth will ensure the Bank remains cautious and will stick to its “gradual and careful” path. Weak, albeit stable, jobs demand will, however, reassure the MPC that a margin of slack will open up this year. We think that will provide enough room for more rate cuts this year without encouraging stronger pay growth. Indeed, we still expect a rate cut in May. 

That said, risks run in both directions. Pay growth is strong. Inflation will be close to 4% later this year and tariff uncertainty will continue to be a risk. Indeed, the Bank’s own surveys show inflation expectations are around 3.4%. This will encourage workers to try and secure larger pay gains to maintain living standards. Additionally, the coming rises in employer NICs and the minimum wage are likely to be passed on into prices, at least initially, as adjusting wage growth will take longer.

However, growth has clearly disappointed recently and that could continue. Against a backdrop of a weakening labour market and if firms pass on budget measures primarily through adjustments to headcounts and wages instead of prices, domestic inflationary pressures could dissipate quickly. That would provide the Bank room for more cuts if they can keep expectations anchored as they look through one-off tariff shocks. 

Ultimately, our base case remains three more cuts this year, before the base rate settles at around 3.5% next year.