UK Labour market: Slower pay growth a big win for Bank of England

The big drop in regular private sector pay growth in the three months to June, down to 5.2%, should go a long way to easing some of the concerns on the Monetary Policy Committee (MPC) about strong wage growth stoking inflation. Admittedly, the drop in the unemployment rate to 4.2% suggests the labour market is tightening again. But the statistics are currently so ropey that it’s difficult to put much trust in them. We think the pay growth figures are more valuable and, looking ahead, we expect private sector pay growth to drop below 5% later in the summer and head towards 4% by the end of the year – that would set the stage for more aggressive rate cuts by the Bank in 2025. 

UK Labour market recovering 

The labour market looks like it is continuing to recover after last years mini-recession. Vacancies maintained their downward trend, falling to 884,000 in the three months to July, down 26,000 on the quarter. That compares with a peak of around 1.3m in mid-2022 and brings job openings a little closer to their 2016-19 average of about 800,000.

Employment grew by 97,000 in the three months to June compared with the previous three months, which, combined with a 27,000 rise in the number of inactive people, was enough to bring the unemployment rate back down to 4.2%. We’re not particularly worried about the impact of this drop in the unemployment rate for a couple of reasons. First, the Labour Force Survey data is still suffering from low sample sizes, which leads to increased volatility, so we are treating the monthly moves with even more caution than usual. Second, population growth continues to be robust, which should help to absorb demand for workers. The renewed increase in inactivity levels is concerning. Solving this problem is the key to boosting growth, lowering interest rates and sorting out the fiscal deficit without having to resort to potentially damaging tax rises.

Pay growth slowing 

We are putting much more faith in the pay growth figures and here the message is clearly that things are easing. Regular private sector pay growth dropped from 5.6% to 5.2% in June, that’s only a fraction above the MPC’s forecast of 5.1%. Wage growth should continue to trend down over the rest of this year as 2% inflation is factored into pay settlements.

Just as importantly for households, real wages grew by 2.4%. That, combined with rising consumer confidence should give a boost to consumer spending in the second half of this year, helping a consumer spending driven recovery.

The policy outlook 

Alongside the decision to cut rates this month, Governor Andrew Bailey delivered the message that the Bank shouldn’t cut rates ‘too quickly or by too much’. That view is unlikely to have changed following the latest jobs and pay data.

The Bank of England is entering a tricky time where services inflation is likely to continue to trend downward, but headline inflation is going to temporarily rise. That will create challenging optics for the central bank as it considers how quickly to reduce the restriction in its policy stance. 

Our base case is that it will lower rates again in November. For a September move to come into view, the data would have to surprise materially to the downside between now and then. As things stand, that looks unlikely.

If wage growth does continue to fall over the rest of this year then it would give the MPC ample cover to cut rates again towards the end of the year, probably in November, and then be more aggressive in it rate cutting cycle in 2025. We currently have four cuts pencilled in for next year.

Sign up to our Real Economy communications for regular commentary and analysis from Tom on the changing economic landscape.