At first glance, the surge in headline pay growth to 8.8 per cent 3myy in June is another reason for the Bank of England to start raising interest rates in mid-2022, but headline pay has been inflated by base and compositional effects. Underlying pay growth is probably closer to 3.0 per cent 3myy. What’s more, there were about 800,000 fewer people in employment in the three months to June than before the pandemic. As such, there is enough slack in the labour market to prevent wage growth from concerning the Monetary Policy Committee (MPC).
Employment rose by another 95,000 in the three months to June, but as the workforce also grew by 59,000, the unemployment rate only ticked down from 4.8 per cent in May to 4.7 per cent in June. Crucially, average hours worked also rose from 29.5 in Q1 to 31.0 in Q2, only a little below their pre-pandemic level of around 32.0. This suggests that the labour market is starting to normalise with those people in work returning to their full shifts.
And employment probably continued to improve in July, which is especially pleasing as firms had to start paying 10 per cent of furloughed employed wages. The number of payrolled employees rose by 182,000 and the number of people claiming jobless benefits fell by 7,800.
Although headline pay growth was a little stronger in June at 8.8 per cent 3myy than the Bank of England’s forecast of 8.5 per cent 3myy, we don’t think this is a big enough divergence to worry most MPC members given the distortions in the pay growth data due to the pandemic. But the MPC singled out progress in the labour market and pay growth as a key input into its decision of when to raise rates at its meeting in August; so, today’s set of strong figures will probably embolden the hawks on the committee and comfort the doves.
The Bank of England is unlikely to alter policy until it sees how the labour market responds to the ending of the furlough scheme in September. The latest estimates suggest there were between 1m and 2m people still on the furlough scheme at the end of June; so, the crucial test is whether these people remain in employment as the furlough scheme ends or if they become unemployed as the scheme winds down.
At its last meeting earlier in August the Bank said that it thought the peak in the unemployment rate was already behind us, and we agree. The number of vacancies hit a record level so there is clearly still strong demand for labour. (See Chart.) And with the level of employment in the economy still much lower than before the pandemic, it’s clear that there is still plenty of room for employment to grow over the rest of the year.
Admittedly, there are some signs that labour shortages in certain sectors are starting to feed through into higher pay growth. Total pay in the construction sector rose by a whopping 14.3 per cent 3myy. As a result, the MPC will be watching for signs that higher pay growth is starting to become entrenched. But as more people move back into the workforce and fewer people have to self-isolate labour shortages should ease over the next year, which will cause underlying pay growth to moderate.
Indeed, we are a bit more optimistic than the MPC on the economy’s ability to bounce back from the pandemic, which is why we think there is probably a bit more slack in the labour market than the MPC realises. This is one reason why we think it will be late 2022 before the MPC is ready to tighten monetary policy, rather than mid-2022 as financial market expects.