15 Mar 2017

UK labour market (Jan): The real wage squeeze is happening

Philip Shaw

Chief Economist

Today’s labour market data presented somewhat of a mixed bag. Employment growth in the three months to January came in at 92k, a pickup from the 37k rise seen in the three months to December and a touch stronger than the 87k consensus expectation.

Meanwhile, the unemployment rate ticked down unexpectedly, to 4.7% (consensus, Investec and December 4.8%). But wage growth was weaker than expected, with whole economy wage growth softening by 0.4pp, to 2.2% (3m yoy), softer than consensus (+2.4%) and Investec (+2.2%) forecasts.

Today’s employment data were encouraging. The 92k growth in the three months to January is in excess of the 70k average three-month increase seen over the past 20 years. The employment rate for those aged 16+ is equal to its record high of 61.0% and the unemployment rate of 4.7% is the joint-lowest seen since 2005 (the jobless rate has not fallen below 4.7% since 1975!). In addition, there was a surge in average weekly hours worked to a joint-record high of 32.3. That helped deliver a 1.5% three-month rise in total hours worked – the largest increase since late-2015. It appears that, from a hiring perspective, businesses have continued to shrug off the uncertainty relating to the prospect of the UK leaving the EU. At face value it also looks like the economy is running at close to full employment.

The healthy employment picture, however, sits at odds with the weakness in the wage data. Whichever way you look at the pay numbers, today’s picture is weak. Alongside the slowing in headline wage growth to +2.2% on a 3m/yoy basis, annual ‘single month’ wage growth dipped to 1.7% y/y; the softest seen since last February. Also, private sector regular (ex bonus) pay growth dropped from 2.8% to 2.6% (3m yoy). And ‘single month’ private sector regular pay growth decelerated from +2.6% to +2.1%; the weakest outturn seen since October 2015. At face value, given the strength of the employment numbers, the extent of the slowdown in wage growth appears puzzling. But we might be seeing some vindication of the MPC’s judgement to revise down the ‘equilibrium’ (ie non-wage-accelerating) rate of unemployment down from 5.0% to 4.5%. In other words, we might be seeing evidence that the labour market can tighten further before generating much wage inflation.

While nominal wage growth has softened, consumer price inflation has been rising. The CPI inflation rate in January was +1.8% y/y, having risen from the sub-1% rates see over much of last year and near-zero rates seen over most of the year before. With ‘single month’ annual pay growth coming in at 1.7%, annual real wage growth per person has actually turned negative (-0.1% y/y). That is a sharp slowdown from the 1.5%-plus growth rates seen for most of last year until last Autumn. There are clear signs, then, that households are beginning to suffer from a real income squeeze. Because household spending makes up around two-thirds of UK demand, this is the main reason why we see the economy slowing down over the course of this year. Indeed, we are forecasting that the CPI inflation rate will peak at around 3% towards the end of this year (primarily reflecting the pass-through of higher import prices due to weakness in the pound). So, unless nominal wage growth begins to accelerate soon, the squeeze on households is set to intensify.

Because of the soft wage picture, and the prospect of a real income squeeze driving an economic slowdown, the MPC will be keen to stand pat on monetary policy for the time being. Granted, we expect the headline rate of inflation to rise to around 3% by the end of this year (well above the Bank of England’s 2% target). But in our judgement, the entirety of that inflation ‘overshoot’ reflects the pass-through of sterling-driven rises in import prices, whose effect should only be temporary.

The MPC appears to share our view that the outlook for domestic inflationary pressures looks subdued. If anything, today’s wage data will make the MPC feel more confident in that view. For that reason, our central view is that a Bank rate rise will not take place until Q4 2019. We might get more clues on that front at noon tomorrow, with the publication of the MPC’s latest decision (see our preview note, ‘Firmly on hold for now…’ for full details).