UK labour market data (Dec/Jan): Domestic inflation softer than expected
15 Feb 2017
Today’s official UK labour market data showed wage growth weaker than expected, with the headline measure posting +2.6% (3m yoy) growth in December, a downtick from the +2.8% (3m yoy) growth seen in November – consensus and Investec expectations were for the growth rate to remain steady this time.
The downside surprise to the wage data is the major news for us today (a view shared by markets, with sterling edging down after the numbers were published). The softness was not confined to the headline measure. Growth in the underlying (excluding bonus) measure also ticked down, to +2.6% 3m y/y, from November’s +2.7% (consensus and Investec +2.6%). Private sector regular wage growth dropped from 3.0% to 2.8% (3m yoy), following four months of acceleration. We also note that the ‘single month’ annual growth rate in private sector regular pay dropped to +2.6% y/y in December (November +3.0%) – the lowest rate seen since last August.
However, we would note that the weakening in the wage data is probably not a signal of a Brexit-related slowdown in the economy. While wages were soft and employment growth modest in Q4 last year, GDP grew by +0.6% over the same period. Alongside that, we draw optimism from the tick down in the (more timely) claimant count rate in January its joint lowest on record (2.1%) (although the Claimant Count data come with the caveat that they are defined by the ONS as an ‘experimental statistic’ due to the inclusion of Universal Credit claimants in the measure less than two years ago).
Strong GDP in the face of soft employment and wages at the end of last year is a tentative sign that the UK economy is capable of expanding through improvements in productivity, while domestic inflation pressures remain low. Indeed, in Q4, with GDP growth of +0.6% and employment (in terms of number of workers) growing by +0.1%, productivity rose by 12% q/q – that is consistent with the long-elusive pre-crisis average and much stronger than the rate which has prevailed since the 08/09 financial crisis. And with underlying wage growth of around 12% q/q in Q4, unit wage costs (the wage cost associated with producing a unit of output) flat-lined over the quarter. If this combination of improving productivity and soft wage growth continues, domestic inflationary pressures should remain contained.
Indeed, these recent signals in the data are consistent with the Bank of England’s view that there might be more ‘slack’ in the labour market than previously thought (the MPC now reckons that the jobless rate can drop to 4.5% before pushing up on inflation, versus a previous estimate of 5.0%). If the MPC is right, then this slack will continue to keep wages in check while the unemployment rate (currently at 4.8%) remains above 4.5%.
We acknowledge that, even if wage pressures do remain soft, the rate of CPI inflation is set to significantly overshoot the Bank of England’s 2% inflation target in the coming months (our forecast is for 3%-plus inflation towards the end of this year). But the vast majority, if not all, of that overshoot is likely to be driven by the post-EU referendum decline in sterling, which is already beginning to push up on imported inflation. But because the sterling effect should be temporary, our view remains that the MPC is likely to ‘look through’ higher inflation for now, keeping Bank rate held at 0.25% until at least the end of 2019. Of late, we have noted that risks to this forecast are probably weighted to the upside, given the unexpected resilience we have seen in the economy in recent months. But if inflationary pressure from the labour market remains as subdued as shown in today’s data, rates will stay on hold.