Labour market data, out this morning, is unlikely to settle any debates for Bank of England watchers.
On the one hand, headline earnings data, which had been expected to rise, surprised to the upside showing wage growth of 8.2% YoY. But unemployment also rose by more than expected, printing at 4.2%, up from 4.0% seen in May. The continued divergence in labour market metrics significantly muddles the picture for the Bank of England. Granted, it all but guarantees a rate increase in September, albeit few in markets anticipating otherwise. But it also raises the prospect of an extension to the Bank of England’s hiking cycle. Whilst growing labour market slack should translate into slowing wage growth, this dynamic is not yet playing out as many had anticipated, and as it will need to do for the BoE to call an end to policy tightening. Given this, expectations for the peak in Bank Rate drove higher once again this morning, having been in retreat over recent weeks. However, we still think a final hike in September is on the cards, albeit with risks now significantly tilted to the upside if a slowdown in wage growth fails to emerge in coming months.
Wage growth will continue to worry the Bank of England
Whilst the substantial upside surprise to earnings data is likely to steal the headlines, drilling down, there are some reasons to think that today’s numbers may not be as bad as they initially look. First, we note that there has been a significant upgrade to the May wage numbers, with the growth in average weekly earnings revised upwards from 6.9% to 7.2%, and once stripping out bonuses, from 7.3% to 7.5%. Second, at least some of the increase seen in today’s figures is attributable to a one off payment to NHS workers in June. This goes some way to explaining the full 1% increase in headline wage growth which printed at 8.2% on a 3m/YoY basis for June, but was accompanied by just 0.3pp increase in the ex-bonus measure which showed normal pay growth of 7.8%. That being said, this is still not good news for policymakers on Threadneedle Street, with wages continuing to grow far faster than the rate consistent with the Bank of England 2% inflation target. This is made most apparent by private sector regular pay growth, a measure identified by the BoE as a key leading indicator for underlying inflationary pressures.
Despite Bank staff forecasts published less than a fortnight ago suggesting that wage growth on this measure should have peaked at 7.7% in May before falling to 7.6% in June, today’s numbers show growth of 8.2%, well above the projected rate of growth.
Worryingly, this is above the rate reported in the Deloitte CFO survey, which found the increase in average wages running at 6.3% over the last 12 months, whilst expecting a decline to 4.7% over the coming 12 months. It is also far in excess of the rate identified in the Bank of England’s own Decision Maker Panel, which had been showing signs of cooling. Whilst we continue to expect wage growth to cool over the rest of the year as labour market slack translates into reduced wage pressure, the BoE will need to see this to be confident of calling an end to policy tightening.
Private sector regular pay growth continues to trend in the wrong direction for the Bank of England, significantly overshooting forecasts from the August MPR
Unemployment figures though are showing signs of cooling that continue to build
In this vein, despite the continued strength seen in wage growth measures, the surprise increase in unemployment is also worthy of note. Having risen unexpectedly last month, today’s data sees the unemployment rate increase 0.2pp to 4.2%, and above consensus anticipation for no-change. Significantly this means that the unemployment rate is now more or less in line with Bank of England estimates for the long term equilibrium unemployment rate of 4.25%. Weakness in employment data was not just limited to the unemployment rate, with the 3m/3m employment change recording a fall of 66k. This was not just down from the 102k recorded last month, but significantly underperformed pre-release expectations for another rise of 90k in today’s figures. Admittedly, the growing weakness in employment is not a surprise.
The latest edition of the REC report on jobs currently shows the balance of permanent placements at -7.6 in July, the lowest level since June 2020 and strongly suggestive of a growing slowdown in employment.
This was similarly reflected in the Deloitte CFO survey which pointed to easing recruitment difficulties, as did the recent S&P PMI report. With slack in the labour market appearing to grow, it seems only a matter of time before this translates to a slowdown in price growth. But given the strength of wage growth seen today, that point is not yet it seems. It is notable then, that the evolution of the Beveridge curve suggests that a larger rise in unemployment will be needed to cool inflation and return the UK economy to pre-Covid norms, and puts the prospect of a larger than expected slowdown in economic growth back into focus as well.
The evolution of the Beveridge curve suggests that cooling inflation is unlikely to be painless
Hot wage data takes Bank Rate expectations higher once again
Whilst we still expect inflation to slow markedly through the remainder of the year, beginning tomorrow as an increase in the energy price cap last year falls out of the YoY calculation, this morning’s data is certainly cause for concern. In our view, a rate rise in September was never in doubt, but the November meeting remains an open question. Rising slack in the labour market suggests a slowdown in pay growth should be in the pipeline. But the BoE will want to see this reflected in hard data before calling a halt to monetary tightening. With two more rounds of labour market data due before the November meeting, there is still time for this to emerge. Therefore, we retain our call for a final 25bp rate rise in September in anticipation of this slowdown playing out, but risks are clearly tilted to the upside after today’s release, with a significant probability that the BoE chooses to extend the hiking cycle beyond the September meeting. This view is also playing out in markets, with swaps now fully pricing a rate hike next month, and a peak in Bank Rate of just under 6%. Whilst this is an overreaction in our view, it has led the pound higher this morning, up 0.2% against the dollar with sterling picking up the typical support from higher Bank Rate expectations.
Nick Rees, FX Market Analyst