U.K. Employment Data May Put Pressure on the Bank of England

Will labor market tightness lead to inflation?

Could BOE Hike First as Fed Plays the Waiting Game?
Simon Dawson/Bloomberg

With all eyes focused on the Federal Reserve ahead of its interest rate decision, the release of U.K. job market data on Wednesday has received little fanfare.

Nevertheless, the figures could provide yet more evidence that the British labor market is in fine health and that Bank of England policymakers could end up falling behind the curve by holding the base rate at 0.5 percent.

In recent months the U.K.’s unemployment rate has been holding steady between 5.5 percent and 5.6 percent, suggesting that the fast pace of job gains seen in recent years may have abated. Private-sector earnings, however, have been picking up pace on a rolling three-month basis.

That said, wage growth remains below what economists expected given the dramatic falls in the jobless figures. Dan Hanson, an economist at Bloomberg Intelligence, said the headline figures may simply suggest that wages are responding to labor market tightness with a longer lag than they have historically, but the gains will ultimately be realized.

“One of the most striking features of the U.K. labor market’s performance over the past two years has been the fact that the rapid erosion of slack brought about by the falling unemployment rate hasn’t coincided with a sharp pickup in nominal wage growth,” Hanson said. “Our view is that this largely reflects pay lagging the movement in the jobless rate, though some of the weakness is likely to reflect the composition of employment gains.”

As the economy recovers, more workers will either be able to negotiate better pay settlements or gain the confidence to switch jobs as employers struggle to fill vacancies. Indeed, there are indications this is already happening.

A survey-based labor market indicator developed by Bloomberg Intelligence economists suggests labor demand is picking up in the third quarter of 2015 while employers are reporting difficulties in recruiting workers for advertised positions.

With headline consumer price inflation currently at zero and the Office for National Statistics’ measure of core inflation declining to 1 percent in August, few expect the Monetary Policy Committee to raise interest rates until the second half of next year. Yet developments in the job market point to a potentially worrisome conclusion—that the pace of labor market tightening is inconsistent with the Bank of England hitting its inflation target over the next two years on the market’s current interest rate expectations.

For its part the MPC does have a potential pressure valve if prices rise, albeit one that’s proved unreliable of late. In the minutes of its September meeting the committee noted: “Although pay growth has recovered somewhat since the turn of the year, the recent increase in productivity means that the annual rate of growth in unit wage costs is currently around 1 percent—lower than would be consistent with meeting the inflation target in the medium term, were it to persist.”

From the 1970s the total amount of hours worked in the U.K. grew 15 percent, while total output has grown more than 160 percent. That’s because of improvements in labor productivity—a measure of the amount of output produced by a worker per hour.

Between 2008 and 2015, however, output merely tracked increases in total hours worked as productivity stagnated.

The return of productivity growth would allow the labor market to continue to add jobs without exerting upward pressure on wages and prices. In fact, if labor productivity continues to grow at the pace it clocked up in the second quarter of this year, the risk to the Bank of England’s inflation target over the next couple of years could be on the downside.

The dismal performance of productivity since the financial crisis and the increased difficulty of finding evidence of substantial labor market slack in the U.K., such as a decline in the prime-age participation rate as seen in the U.S., are starting to shift the balance of risks in favor of a modest rate hike. If wage pressures build, the bank may yet be forced into action earlier than markets currently anticipate.

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