Labour market tightening but biggest test yet to come

The remarkable labour market recovery continued in August, which will embolden the hawks on the Monetary Policy Committee (MPC). The real question now is how the labour market handled the end of the furlough scheme in September. There may be a temporary rise in the unemployment rate as some previously furloughed workers have to find new jobs. Our view is that a small rise in unemployment in October will be enough to stop the MPC raising rates until the second quarter of 2022, by which time the economy should have recovered just enough to cope with higher interest rates.

The fall in the unemployment rate from 4.6% in July to 4.5% in August was driven by a rise of 235,000 in the number of people in employment. This left the employment level about 300,000 below its pre-pandemic level. It looks like the winding down of the furlough scheme didn’t lead to a surge in unemployment in September, because other figures released today show an increase of 207,000 in the number of people on payrolls and a drop of 51,000 in the number of people claiming job seekers allowance. To see how the end of the furlough scheme affected the labour market, we’ll have to wait until this time next month for the first glimpse of October’s data.

Meanwhile, total vacancies continued to rise and hit a new record of 1.1 million and there was evidence that the issue is becoming more widespread throughout the economy. Vacancies in all industry sectors were above or equal to their pre-pandemic levels in September, and the biggest increase was the nearly 50,000 additional vacancies in the accommodation and food service sectors. So, there’s not much sign of any easing in labour shortages yet. The ending of the furlough scheme and the return of students to universities and part-time work should help a little over the next few months, but labour shortages are going to be an issue for most of the next year.

At the same time, headline pay growth fell from 8.3% in July to 7.2% in August as the distortions from the pandemic have started to ease. The Office of National Statistics said that underlying pay growth is probably around 4% to 5.5%. That’s a bit higher than the ONS thought underlying pay was in July (3.5% to 5%), and significantly above the pre-pandemic level of about 3%. Pay growth of around 3.5% is probably consistent with the MPC’s 2% inflation target, so faster pay growth may fuel some of the MPC’s concerns that the rise in inflation is becoming more persistent, even though the outlook for the wider economy has weakened recently.

Rising underlying pay growth has clearly spooked some MPC members, but it’s likely that even they’ll want to see how the labour market has coped with the end of the furlough scheme. A large rise in unemployment, combined with surging energy prices and shortages, could take some of the heat out of both the labour market and the economy, and undermine the case for an imminent rate rise. However, there is a large and growing chance that the MPC decides it can’t wait to see the full impact of the ending of the furlough scheme and decides to raise rates before the end of the year.