UK reaction: Labour market not unequivocally supportive of a May hike
David Page, Senior Economist at AXA Investment Managers (AXA IM) comments on the latest figures on the UK labour market.
- Momentum in UK employment growth improved with employment rising by 168k in the latest report – a seven month high.
- The unemployment rate fell back to a 42-year low of 4.3%, although the number of unemployed rose.
- A strong rise in economic activity highlights the uncertainty in gauging the degree of spare capacity in the UK labour market.
- Average earnings rose and the annual growth rate reached a 15-month high, with some of the fastest growth over the past two and a half years.
- However, the quarterly pace of wage growth – watched by the Bank of England (BoE) – slowed and questions any material improvement over the last three years.
- Tomorrow’s Monetary Policy Committee (MPC) decision will guide whether the MPC wants to tighten policy as soon as May.
Employment growth in the three months to January rose by 168k, the fastest 3-monthly expansion since the 3-months to May and towards the top end of the range of employment growth for the last two years. Employment was made up of predominantly full-time employees (+182k), with self-employed falling 27k and part-time workers down 6k over the latest three months.
The unemployment rate fell back to 4.3%, resuming its 42-year low. However, the number of unemployed rose again, up 24k on the last 3-months. The rise in total unemployed, despite robust gains in employment, was the result of a strong increase in labour supply, something which asks broader questions about UK labour market spare capacity. This month’s result reflected a large rise in the work force of +192k, which was driven by a significant increase in female participation aged 25-49 and males aged 25-34. The corollary of a sharp decline in inactivity sheds little further explanation on this rise, with a 118k decrease in inactivity due to a fall in numbers “not wanting a job”, over half of this describing their reasons as “other”. The increase in economic activity is all the more noteworthy given the 106k decline in employment from migration (14k EU, 92k non-EU) reported in the 3-months to December. Overseas workers employed in the UK rose by just 29k in 2017, this was the smallest increase since the recession in 2009 (when it fell by 92k) and compares with a 449k increase in 2016 and an average 260k annual increase since 2010. Moreover, UK workers are working fewer hours, on average, than before. The UK average work week fell to 32.1 hours per week in the 3-months to January from 32.3 hours one year ago. This was predominantly driven by a reduction in full-time working hours to 37.3 hours from 37.7 hours.
Wage growth accelerated on an annual basis, recording 2.8% (headline, 3m yoy) and 2.6% (excluding bonuses), the headline firmer than market expectations (of 2.6%). This was the strongest annual wage growth since November 2016 and looks set to accelerate further next month following weak base effects, which could take wage growth to a 30-month high. On the face of it, this is primae facie evidence of a tightening labour market. However, at this stage it is not clear that wage growth is meaningfully accelerating above the pace seen on average over the past three years (see chart below). We have argued that the January-April pay rounds will prove key and while we expect to see evidence of faster pay growth, we would like confirmation of such an outlook before tightening monetary policy further. The BoE has pointed to a much faster quarterly annualised pace of pay growth in recent quarters as evidence of pay acceleration. However, after a buoyant Q2 and Q3 2017 (themselves following subdued previous quarters), this pace has softened back to 2.5% - consistent with the 3-year average. We still do not see material evidence of pay acceleration in the official statistics, even though our forecasts continue to point to a quickening across the course of this year.
Source: Office for National Statistics - ONS
The implications for the Bank of England are mixed. Faster employment growth, a fall in the unemployment rate and a rise in annual pay growth all suggest a tightening labour market that threatens domestically generated inflation and requires tighter monetary policy. However, the increase in domestic labour supply raises questions about the scale of remaining capacity. Wage growth remains a key indicator of this degree of spare capacity, but we argue today’s data do not provide evidence of a material acceleration – even though we expect this over the course of the year. Given other downside risks to the UK outlook (primarily the ongoing impact of Brexit uncertainty on business investment), we argue that this would urge caution on the part of the MPC, which is why we forecast an August rate hike, after we see January-April wage hike evidence.
However, Bank of England communication has led the market to conclude that it will tighten policy in May (suggested with a roughly two-thirds probability). Unlike the Grand Old Duke of York, the MPC is unlikely to want to run market expectations up for a hike, only to disappoint and see them come back down again. Governor Carney has been keen to stress that he does not provide specific rate outlooks except in exceptional circumstances. We suspect that tomorrow’s Bank Rate decision (where we expect no change in policy) will be the last opportunity to send a more equivocal signal to the market over the outlook for a May hike. We believe a more cautious outlook is warranted and for now maintain an August forecast, but tomorrow looks set to prove whether the MPC share our view.
Financial markets reaction to today’s labour market data was less guarded. 2-year and 10-year yields rose by 5bps and 3bps respectively to 0.94% and 1.53%, while sterling firmed further by 0.45 to the US dollar and 0.25% to the euro as markets became more convinced of the case for a Bank Rate hike.
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