David Page, Senior Economist at AXA Investment Managers (AXA IM) comments on today’s labour market report - “Mixed messages”

• Pay growth continues to look solid. We expect annual growth to rise towards 3% over the coming couple of months, but the annualised pace of increase softened in Q4.
• Employment growth rose by 88k, but the pace over H2 has slowed from H1 and may suggest a more modest pace of increase ahead.
• Productivity growth has accelerated and the implied pace of Q4 output per hour exceeds 3% on an annualised basis.
• Unemployment rose to 4.4% from 4.3%, but reflected a greater rise in economic activity than employment. There appears little scope for material further increases here.

 

• We do not believe the MPC is committed to a May hike - wage data over the next two months is likely to be critical to this outcome.
• For now we continue to forecast an August hike, but continue to forecast multiple hikes (to 1.75%) by end 2020.  

 

“Today’s UK labour market update, for the three months to December 2017, provided mixed signals for the UK economy: employment rose but was absorbed by more slack in the economy, implied productivity growth accelerated, but wage growth also quickened.

 

“Employment growth rose in Q4 by 88k. This was an improvement on the 14k contraction in growth recorded in Q3, but fell short of the expected 165k consensus forecast. Employment growth in H2 2017 averaged 38k over the two quarters, compared with 123k in H1 suggesting some deceleration. Total employment growth recorded 321k in 2017, modestly firmer than 298k in 2016, but materially lower than the 586k in 2015 and 652k in 2014. Accordingly, productivity growth (output per worker) continues to improve. Output per hour in Q4 looks to have increased at a 3%+ annualised rate with average hours worked contracting by 0.3% on the quarter (and Q4 GDP growth up 0.5%).

 

“At the same time, the unemployment rate rose marginally to 4.4% from 4.3% (and above the 4.3% consensus expectation). The rise, despite an 88k increase in employment, reflected the larger 134k increase in economically active. While this reflected increases in 35-64 year olds, it was significantly boosted by a 36k rise in 18-24 year olds, where economic activity rates rose to 69.6% from 68.8%. This appears consistent with a 59k quarterly drop in those reported as economically inactive students. Overall economic activity rose to 63.6%, close to the 63.8% -multi-decade high. This will add to the Bank of England’s (BoE) assessment that UK slack is being eroded.           

 

“Wage growth was reported modestly firmer than expected. Headline 3m year on year total pay growth remained unchanged at 2.5% as expected, but ex-bonus pay growth accelerated to 2.5% from a downward revised 2.3% the previous month (from 2.4%). Annual pay growth rose to 2.8% (including bonuses) and 2.6% (excluding bonuses), respectively the fastest rates since June 2017 and November 2016. The general outlook for pay growth is consistent with our outlook for UK earnings growth. The next couple of months is likely to see annual pay growth rise further, reflecting very weak pay growth in January and February last year. This suggests pay growth should rise to around 3% over the coming months. However, unless pay accelerates more materially than we forecast, we do not see it settling there until later in the year.

 

“The Bank of England is likely to take a number of mixed messages from this month’s report:

 

• Primarily the outlook  for wage growth remains solid. However, the Monetary Policy Committee (MPC) places a lot of faith in the annualised quarterly figures illustrating a recovery in wages. This annualised pace decelerated in Q4 to 2.5% from >3% in the previous two quarters. While our models concur with anecdotal evidence that annual wage growth should accelerate over the coming months, we will watch the important January-April wage data over the next four months for confirmation of our forecast. Given the BoE’s prior record on wage growth forecasts, it too may seek further confirmation of its forecast over the coming months.
• Employment growth may be continuing to slow. If this persists it suggests a less inflationary outlook, not least given the implied recovery in productivity growth.

 

“The mixed nature of this month’s report underlines our relative caution in suggesting the BoE will hike rates at the next Inflation Report meeting in May. For now we retain a more cautious August hike forecast and suggest this will be the only hike of 2018, although we clearly recognise the risk of a May move and two hikes this year. However, our outlook for the degree of tightening remains unchanged overall considering five hikes likely by the end of 2020 (Bank Rate at 1.75%), compared with four hikes inferred from the BoE’s latest forecasts.

 

“Financial market reaction was equally muted. 2-year gilt yields were unchanged at 0.67%, but 10-year yields eased back 1bp  to 1.55%. Sterling softened by 0.2% and 0.3% to the euro and US dollar respectively. The probability implied from rate markets for a May rate hike remains over 50%, but market expectations have slipped from immediately after the Inflation Report when the market considered a 65% likelihood of a 0.25% hike.”   

ENDS