UK wages and employment: a mixed picture

Rather than fading in importance, employment trends remain front and centre for the Bank of England’s MPC in determining where next for interest rates. Although there are some signs of weakening, it’s very much a mixed picture, and an inconclusive one for inflation and interest rate trends – by Rob Morgan, Chief Investment Analyst at Charles Stanley

Unemployment, having held steady at 4.4% for several months ticked up in the three months to March to 4.5%, plus there is now a clear trend of a drop off in employment. Yet household spending firepower, taken in the round, continues to be bolstered by wage growth, which at 5.6% is still very much at odds with the BoE’s 2% inflation target. What’s more, figures to the end of March don’t yet capture the full effects of the increases in minimum wages and employer national insurance costs.

In its quarterly monetary policy report published last week, the Bank of England stated the impact of higher National Insurance contributions on employment levels “appears to have been relatively small to date”. If indeed employers are making few adjustments to their workforce, it suggests they are erring towards passing on higher costs through price increases. This could push up services inflation but keep unemployment quite low despite a drop off in hiring.

An inflationary pulse?

An increase in the minimum and living wages, which is occurring in tandem with the rise in NI costs stands to propel pay higher at the same time the labour market is cooling. As well as directly impacting lower earners, there is a probable ratchet effect across a wider cross section of the workforce whereby more senior staff expect to maintain a pay differential over lower ranking workers.

It is perhaps this effect that rate setters on the MPC need to be concerned with as much as the rise in NI. The impact on labour-heavy services inflation will be at least pause for thought for those looking for prices to trend lower, plus it provides an indication of the resilience of the UK economy amid interest rates that are still somewhat restrictive. However, it also fair to conclude the effect, as with NI, will wear off over time and as such provide an inflationary pulse before subsiding.

Where do UK interest rates go from here?

The intriguing three-way split on the interest rate decision last week reflects the broad range of views held by members of the MPC, as well as the array of plausible inflationary scenarios.

Those expecting a swifter pace of easing in the second half of the year in the case of a softer labour market, lower pay settlements, and more benign services inflation could ultimately be vindicated. However, the Bank will want to keep its options wide open. A decent growth picture combined with continued resilience in the job market will likely see a pause in the quarterly cadence of interest rate cuts we have seen over the past year.