The labour market is still red hot, thanks in no small part to soaring levels of sickness, which hit a record high in September. This is pushing up pay growth and makes it more likely that the Monetary Policy Committee (MPC) will have to raise rates again in December. However, in digging a little below the headline data, there are signs that the labour market might be easing.
The key unknown for monetary policy is how many of these inactive people will be tempted back into the workforce due to the cost-of living-crisis. This will make a big difference for how quickly the unemployment rate rises, how fast wage growth comes down and how high interest rates will have to rise.
First signs of tightening
There are now some reasonably clear signs that demand for labour is starting to weaken. Vacancies continued to fall, dropping by another 46,000 on the quarter, and employment, based on the labour force survey, fell by 52,000 in the three months to September.
Indeed, in the three months to September the unemployment rate ticked up to 3.6%, from 3.5% in the three months to August, as there were an extra 36,000 unemployed people. What’s more, the single month measures, which are admittedly quite volatile, showed a massive 249,000 drop in employment and a 136,000 rise in unemployment. Admittedly, part of that will just be an unwinding from equally large rises in August. But the single month measure of unemployment is now at its highest level since April.
So, while the labour market is still obviously extremely tight, there are perhaps the very first signs that it was starting to ease in September. However, the big issue is still the huge number of people inactive from the workforce, which increased by another 108,000 on the quarter. It will be extremely difficult for economic growth to rebound strongly without getting more people into work.
The one silver lining is that immigration has remained reasonably strong. The number of non-UK nationals either working or looking for a job in the UK increased by 207000, or 3.3%, year-over-year in Q3. The recent combination of increasing UK wages, but stable minimum salary thresholds for UK visas, suggests that immigration will remain strong over coming quarters.
We expect vacancies to continue falling sharply over the next year as firms reduce their demand for labour. The recession will also raise unemployment levels but, given the surge in the number of people on long-term sick leave significantly reducing the workforce, the unemployment rate is likely only to rise around 5%, a historically low figure, especially during a recession.
Pay growth far too strong for the comfort of the MPC
The tight labour market means growth in regular pay (excluding bonuses) was 5.7% among employees in the three months to September 2022. This is the strongest growth in regular pay seen outside of the pandemic period. Average regular pay growth was even higher a 6.6% for the private sector – that is miles above the 3%-3.5% that’s consistent with the 2% inflation target. Although, given soaring inflation, in real terms over the year regular pay fell by 2.7%, a near-record drop.
Pay growth is probably near its peak, though. The slowdown in hiring will lead to less churn in the job market, easing the pressure on businesses to pay more to retain staff. However, the Bank of England will want to see concrete signs of easing wage growth before they consider pausing the tightening cycle. That probably won’t be until Q2 next year as the labour market lags the real economy significantly.
The MPC is likely to reduce the pace of tightening at its next meeting after delivering a jumbo 75 basis point hike earlier this month. Our base case is for the BoE to raise rates by a still significant 50 bps in December and for interest rates to peak at 4.5% early next year.
However, Chancellor Jeremy Hunt’s Autumn Statement will have a bigger impact on the outlook for inflation next year. A big swing to austerity would weaken the economy and reduce the need for further rate hikes.