November’s strong labour market figures mean it’s more likely that the Monetary Policy Committee (MPC) will raise interest rates again at its next meeting on 3 February. After that, however, we expect the MPC to be more cautious as employment growth slows, wage growth cools further and real incomes are depressed by the surge in inflation.
The 60,000-strong rise in employment in November was enough to drive the unemployment rate down from 4.2% in October to 4.1%. Admittedly, the single-month figures looked worse than the three-month averages (3myy). They showed that, after falling by 219,000 in October (when the furlough scheme ended), employment fell by a further 118,000 in November. But the 184,000 rise in HMRC payrolls and 43,300 drop in the claimant count in December suggests that hiring remained robust at the end of the year, despite the emergence of omicron.
Total vacancies also continued to rise and reached another record level of 1,247,000, and there was evidence that the issue is affecting every area of the economy. Vacancies in all industry sectors were above or equal to their pre-pandemic levels in November.
We expect the labour market to continue to tighten over the rest of this year, but at a slightly slower pace as gains in employment start to run up against a smaller post-pandemic workforce – the 275,000 increase in the number of ‘inactive’ people has been driven mainly by a 265,000 increase in the number of people on long-term sick leave. This may be an after-effect of the pandemic, but any easing will only be gradual. Combined with lower inward migration as a result of Brexit, the UK’s workforce is likely to grow more slowly than it did before the pandemic.
Real pay will fall
At the same time, headline pay growth fell from 4.9% 3myy in October to 4.2% in November although that’s still above its pre-pandemic level of about 3%.
Most of the distorting factors that had been pushing headline pay growth up have worked their way out of the data, but real pay growth is now negative and we expect it to remain that way for most of 2022. This will reduce consumer spending, especially at the lower end of the income distribution where households spend a larger share of their income on utilities, the price of which has soared.
The policy takeaway
The MPC’s decision to lift rates in December was a clear signal that it has shifted into inflation-fighting mode. With the labour market tightening, it’s worried that high inflation will start to have an impact on perceptions of future price gains. Today’s data is unlikely to do anything to alleviate those concerns.
At its February meeting, the MPC will be forced to make a large upgrade to its inflation forecasts to reflect higher-than-expected energy prices. Given its desire to shore up its inflation-fighting credentials, there’s a clear argument for the central bank to act before inflation spikes in April. Every sign points to interest rates rising from 0.25% to 0.5% next month.
However, that will probably be the last move for a while and we expect the benchmark rate to end 2022 at 0.75%. That’s because slower wage growth, negative real incomes, and the possibility of inflation dropping below target in 2023 if energy prices fall are all reasons for the MPC to tread carefully before it lifts rates again.