As the UK navigates its post-pandemic economic landscape, the dynamics between the labour market and interest rate policies remain at the forefront of monetary discourse. Recent data suggests a complex scenario where employment trends, wage growth, inflation, and consumer spending directly influence the Bank of England’s (BoE) decisions on interest rates. This blog explores the current state of the labour market, the implications for interest rate cuts, and what we might expect moving forward.

The Labour Market: A Mixed Bag of Signals

Recent labour market data has painted a somewhat optimistic picture for the UK economy. Employment figures have shown resilience, with the official Labour Force Survey (LFS) reporting a significant rise in employment during June. The number of employed individuals surged by 97,000 over three months, marking the most robust growth since November 2023. The payroll (PAYE) measure of employment also indicated an increase, albeit more modestly, with a rise of 24,000 in July.

This robust performance has been further underscored by a decrease in the unemployment rate, which fell to 4.2% in June from 4.4% in May. This drop was more significant than anticipated, suggesting a genuine improvement across various age groups and sectors. Notably, the single-month jobless rate for June dropped to an impressive 3.6%, although this figure is considered somewhat erratic due to the nature of the data collection.

However, while these figures might suggest a booming labour market, the underlying trends warrant a more cautious interpretation. The overall workforce has seen minimal growth since 2019, indicating that while employment is rising, the broader labour market remains relatively stagnant. Furthermore, wage growth has begun to slow, aligning with the BoE’s forecasts for Q2. Private sector average weekly earnings, excluding bonuses, increased by 5.2% year-on-year in June, a noticeable deceleration from earlier.

Pay Growth: A Point of Contention for Doves and Hawks

The recent trends in pay growth provide a mixed picture for the BoE's Monetary Policy Committee (MPC), which is currently divided between doves advocating for looser monetary policy and hawks pushing for continued caution. The main measures of pay growth continued to cool in the three months to June, although this was primarily influenced by base effects from last year's significant increases.

The drop in total pay growth across the economy was particularly pronounced, falling to 4.5% in the three months to June from 5.7% in May. This decline was influenced by one-off bonuses paid to National Health Service and civil service workers last June. Meanwhile, private sector regular pay growth dropped to a 25-month low of 5.2% in June, further complicating the MPC's deliberations.

The slowdown in pay growth will likely solidify the well-entrenched positions of the two camps within the MPC. The doves will view it as evidence that the inflation shock is dissipating, providing room for gradually loosening monetary policy. In contrast, the hawks will argue that pay growth, although slowing, is still too high to ensure that inflation will return to the 2% target over the medium term. This debate highlights the ongoing uncertainty surrounding the labour market and its implications for inflation.

Inflation Trends and Their Impact on Policy

Recent inflation data adds another layer of complexity to the BoE's policy decisions. Headline CPI inflation rose slightly to 2.2% in July from 2.0% in June, a figure below both market expectations and the MPC’s forecast. This increase was primarily due to smaller-than-expected reductions in utility prices. However, the more critical measure of services inflation, which the MPC closely monitors as an indicator of underlying inflation pressures, fell sharply to 5.2% in July from 5.7% in June. This was significantly below expectations and suggests that inflationary pressures may be easing faster than anticipated.

Despite this, the MPC is likely to adopt a measured approach. The committee has indicated focusing on broader trends rather than reacting to individual data points. The gradual slowdown in services inflation opens the door to further rate cuts, but given the mixed signals from the economy, the MPC appears inclined to wait until November for the next reduction.

Gradual Rate-Cutting Cycle: The Likely Path Forward

The BoE's Monetary Policy Committee has been clear about its intention to take a cautious approach to loosening monetary policy. Although recent data on pay growth and inflation show some progress, these indicators still need to provide the substantial downside surprises the MPC requires to consider more aggressive rate cuts.

GDP data from June showed that the economy was flat, with no growth month-to-month, leaving output up 0.6% for Q2 2024. This followed a stronger Q1, but the outlook suggests that the economy may struggle to sustain the above-trend growth rates seen in the first half of the year. Despite this, further real wage increases and rising consumer sentiment could still support decent GDP growth in the coming quarters, albeit at a more moderate pace.

Given the current economic landscape, we anticipate that the MPC will continue to opt for a gradual rate-cutting cycle. The dovish majority within the committee, supported by the recent cooling in pay growth, is likely to argue for a measured approach, ensuring that policy adjustments do not outpace the decline in inflationary pressures. On the other hand, the hawks will likely remain cautious, emphasising that wage growth and inflation are still above levels consistent with the BoE's medium-term targets.

As we approach the BoE’s next meeting in September, it seems increasingly likely that the MPC will maintain the Bank Rate at 5%, with the next 25bps cut potentially being delayed until November. Governor Andrew Bailey is expected to reinforce this cautious stance at the upcoming Jackson Hole symposium, underscoring the need for the MPC to "be careful not to cut rates too much or too quickly."

Retail Sales: A Rebound in July

The retail sector, which experienced a notable rebound in July, adds another layer to the economic outlook. Retail sales volumes rose by 0.5% month-on-month, following a sharp 0.9% decline in June. This increase was primarily driven by a recovery in non-food retailing, which benefited from summer discounts and increased spending during sporting events.

However, the retail sales series is notoriously volatile, and recent data could be more accurate. Despite the noise, there are signs of a gradual improvement in sales over the past year. The consumer outlook remains relatively upbeat, supported by sustained real wage gains, which should bolster household income growth. As consumer confidence rises, we expect retail sales to strengthen further in the second half of 2024 and into 2025.

Nonetheless, tighter fiscal policy and the lagged effects of past interest rate rises will continue to weigh on spending power. Real incomes have grown enormously over the past year, putting household finances on a firmer footing. Still, the overall impact of rising debt service payments for mortgage holders remains a concern. If consumers maintain a less cautious attitude towards spending and credit demand, the retail sector's fortunes should continue improving.

What’s Next?

Looking ahead, the trajectory of interest rates will largely depend on how the labour market, inflation, and consumer spending trends evolve in the coming months. If employment rises, wage growth stabilises, and retail sales maintain upward momentum, the MPC may opt for a more gradual approach to rate cuts, possibly waiting until November or beyond to make any significant moves.

The key factors to watch will be the vacancy-to-unemployment ratio, the overall tightness of the labour market, the trends in services inflation, and consumer spending patterns. Recent data suggests that while the labour market has loosened compared to 2022, it remains historically tight. Similarly, despite the recent volatility, the gradual easing of services inflation points to a slower but steady path towards the BoE's inflation target.

In conclusion, the UK labour market’s resilience, the evolving inflation landscape, and the recovery in retail sales have introduced a new layer of complexity to the BoE’s monetary policy decisions. While there is a clear case for caution in cutting interest rates, the evolving economic data will be crucial in shaping the MPC’s approach. As we move towards the latter half of the year, the interplay between employment trends, wage growth, inflation, and consumer spending will determine the pace and timing of further rate cuts.

Have a great week.