Unscathed labour market suggests December rate hike

The labour market appears to have escaped the end of the furlough scheme relatively unharmed. If the official data for October tells a similar story, and we think it will, it means the Monetary Policy Committee (MPC) is now more likely to raise interest rates in December.

The 160,000 rise in payrolls for October suggests that only a small proportion of the 1.1 million people still on the furlough scheme in September became unemployed. In fact, the claimant count fell by 14,900. As a result, the claimant count rate dipped from 5.2% in September to 5.1% in October. 

What’s more, total vacancies have continued to rise, hitting another record of 1.172m. Now that 15 of the 18 industry sectors show record vacancy levels, there’s clear evidence that the issue is becoming more widespread throughout the economy. It seems that the end of the furlough scheme hasn’t helped to ease labour shortages.

None of this is official data so the MPC will want more evidence to be sure that the labour market is recovering. But the official data for September indicates that the labour market recovery was robust. The fall in the unemployment rate from 4.5% in August to 4.3% in September was driven by a 247,000 rise in employment. This left the level of employment about 500,000 smaller than it was before the pandemic so there is still plenty of scope for further gains in employment over the next few months. 

Underlying pay growth will remain strong

At the same time, headline pay growth fell from 7.2% 3myy in August to 5.8% in September. Pay growth remains distorted by the pandemic, but we think that underlying pay growth is probably around 4% – 5%, roughly the same as in August. That’s still above its pre-pandemic level of about 3%. 

Pay growth of around 3.5% is probably consistent with the MPC’s 2% inflation target. Faster pay growth may therefore 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.

The policy takeaway

The continued robust recovery in the labour market should reassure those MPC members who were concerned about damage from the ending of the furlough scheme.

The next batch of official data will be published on 14 December, just before the next MPC meeting on 16 December. We think it will follow the payroll and claimant count data and show that the labour market remained strong in October. In this case, most MPC members could decide that the labour market is now healthy enough to withstand an interest rate hike. Indeed, Andrew Bailey said the decision to keep borrowing costs at historic lows had been ‘a very close call’, so a strong October labour market report may be enough to convince the fence-sitting members of the MPC to go for a rate hike in December.

Admittedly, a December rate rise is far from a done deal. Even if there isn’t a large increase in unemployment in October, there is likely to be evidence of further underemployment (many formerly furloughed employees are working fewer hours than they would like). In addition, the MPC flagged its concerns about the slowing economy so it’s unlikely to be reassured by the data released between the last meeting in early November and the next in December.

On balance, we think that today’s data should be enough to convince most MPC members to hike rates in December, although given the slowing economic recovery it will be a tight vote. In any case, interest rates will rise only gradually and remain very low by historical standards. Real interest will remain negative for a long time to come.