Analysis: The UK labour market and the Bank of England’s shift to higher rates
In its jobs report released earlier today, the ONS reported that unemployment held steady at 3.8% in the United Kingdom, a fall of 0.1% on a quarterly basis, and a decline of 1.1% over the last 12 months. This marks the fifth consecutive three-month rolling period where unemployment has been under 4%, i.e., since November 2021.
Fresh data sparked concerns about both surging inflation and real wage erosion outside the crème de la crème of high earners.
The jobs data followed an unexpected improvement in GDP data published last week, which rose by 0.5% in May compared to April, while it grew by 3.5% on an annual basis. Statistics for March and April 2022 were also revised upwards to an expansion of 0.1% and a contraction of 0.2 % compared to preliminary figures that showed contractions of 0.1% and 0.3%, respectively.
Gabriella Dickens of Pantheon Macroeconomics said that the current rebound is likely driven by easing supply chain disruptions and the fulfilment of backlogs in past orders.
Following the unanticipated expansion in economic growth, consumer inflation of 9.1% in both the UK and the US, and a tight jobs market, the Bank of England (BoE) is likely to raise the policy rate by 50 bps during its 4th August meeting, as compared to its five earlier consecutive increases of 25 bps.
The primary driver here is the probability of Fed acceleration with 66.8% of respondents pricing in a three-quarter percentage point hike, while 33.2% expect a full percentage point increase, as per the latest report by CME’s FedWatch Tool.
Key jobs data
The unemployment rate stayed at 3.8% with tightness in the market confirmed by a BoE survey that found two-thirds of companies were finding it “much harder” than usual to hire staff, the highest level since the question was introduced in October of 2021. 88% of firms reported that it was “harder” to hire employees.
The tightness in the market may be partly been driven by lower immigration, elevated retiree numbers, and “a quarter of a million extra people out of the jobs market due to long-term sickness compared to pre-pandemic” as reported by ING.
Looking at a complete overview of the job market, the most encouraging aspect is the fall in the inactivity rate, which implies that more workers are either employed or searching for a job. If this trend continues, search and match should become easier for firms.
Moreover, the redundancy rate has been falling, suggesting that firms are more willing to retain employees amid higher costs of search, training, and replacement.
In the figure below, we find that the largest increases in employment are among full-time staff, while part-time opportunities are seeing a slowdown. With a tighter job market, it may be that some workers have gravitated from part-time to full-time opportunities.
In light of labour market activity, Paul Dales of Capital Economics said that “the economy is holding up well in the face of high inflation”.
However, it is important to note that labour market strength is typically a lagging indicator, with unemployment rates often being strongest near the beginning of a recession, while they peak in the aftermath of a slowdown.
This is especially clear in regards to US data as shown below where the grey shaded sections represent recessions.
Source: US FRED
At the onset of a recession, managers are still to come to terms with supply dynamics and crystalize demand outlooks. Incentivized by falling real wages, layoffs are stalled and hiring often rises. On the other hand, while exiting a slowdown, managers need time to build confidence after a period of prolonged pessimism, and this hiring hesitancy can lead to subdued head counts.
With a further hike expected from the BoE, it is yet unclear if unemployment will remain relatively stable while corporations choose to shift to “reducing staff hours” as reported by ING economists, or if the slowdown in growth and high debt/GDP ratio will usher in a full-blown economic downturn.
Labour market inequality and the cost of living
Despite the tightness in the labour market, real wages have disappointed, falling 2.8% in the previous three months which is the sharpest decline on record. Accounting for inflation, total pay (including bonuses) fell 0.9% lower from March to May 2022 compared to 2021.
Although the rising inflation does not seem to have yet affected the demand for labour, the impact of labour pay has been sharply divergent among the workforce.
Bloomberg reported that nominal wages have only risen by 1.3% annually for the bottom 10% of workers in the UK. These workers typically earn under £8,300 in the year, a tier of approximately 3 million people. Incomes are being squeezed by consumer inflation which has topped 9% and is expected to accelerate to 11% during the winter, despite the long series of rate hikes.
However, the labour market has been much more beneficial for those at the top of the food chain, with the highest earning 1% of the UK, seeing pay rises of 9.1% this year, in step with inflation. These workers are highly skilled and typically earn over £170,000 a year.
Although crude oil prices have eased since earlier this year, they are still at historically elevated levels with both WTI and Brent trading above $100 per barrel at the time of writing.
As a result, the research found that energy prices have skyrocketed for the average family, rising 54% in April, according to Cornwall Insight, a research firm. Annual fees could rise above £3,000 with the implementation of October tariffs on energy consumption.
Low earning households have been forced to dip into their savings, to stave off food poverty with food inflation at 15% over the last 12 months, driven by the ongoing Russia-Ukraine war.
The BoE’s sixth hike
The BoE has hiked by 25 bps consistently for the past five meetings. However, market expectations are that firm job data, an unexpected rise in GDP, high inflation projections, and accelerated Fed tightening will cause MPC members to vote for a 50-bps hike.
Inflationary pressures could also emerge from the trade deficit, which widened to historic levels since records began, reaching £28 billion in the past 3 months.
If the Fed does decide to raise its rates by 1%, this will be the first such hike since 1981, while inflation was also above 9% per annum.
Despite the unexpected upside to GDP, the UK is projected to experience no growth in 2023.
Rising rates could be a recipe for stagflation and the onset of lay-offs in the future.
Moreover, disappointing corporate earnings reports could signal a coming slowdown, with Made.com, an online furniture retailer plunging nearly 40% in a single trading session as it sees no uptick in demand for discretionary items.
Broadly, the UK is in a precarious position with the recent resignation of PM Johnson while the ongoing political turmoil will lead to a deeper sell-off in the sterling. A weakening currency would result in higher import prices and eventually more inflation.
Despite these challenges, on balance, we expect the BoE to raise rates by 50 bps in the coming meeting to guard against higher inflation and preserve currency strength. With rising inflation, the central bank will try to stamp its authority on the monetary landscape to maintain policy credibility.
Although job data is one component of the equation, it is likely to have had a muted effect on policymakers ahead of the BoE meeting. According to an article by ING economists, “In practice this data is unlikely to change many minds…hawks will stay concerned about worker shortages, while the doves will focus on the pick-up in shorter-term unemployment.”
As per a recent Institute of Directors survey, however, the worst is yet to come, with two-thirds of business leaders anticipating that inflation will peak in the spring of 2023, or later. This may prompt the BoE to frontload rate hikes.
The BoE is likely to hike rates and assume a wait-and-watch position vis-à-vis job data while trying to maximize policy flexibility.
However, this could lead to stagflationary risks, especially in consumer-facing sectors such as pubs, restaurants, and entertainment venues, which are already experiencing declining output.
Moreover, with real wage suffering, it will be very challenging for low-income households to cope with higher borrowing costs. Ben Harrison of the Work Foundation of Lancaster University tweeted, ”The harsh reality is it will be acutely worse for the 6 million people in the UK who are in severely insecure work, and already face low pay and uncertain hours.”
With the ongoing Russian invasion of Ukraine and subsequent supply disruptions, as well as a strengthening dollar, inflation is likely to persist for the foreseeable future. The government would be well-advised to ensure mechanisms to ensure sustainable wages, although fiscal headroom remains limited.
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