Haywire labour market driving split at Bank of England

Andrew Bailey and his colleagues at the Bank of England all agree that inflation must be crushed.

Unfortunately, they don’t agree on the best way to do it: policymakers are split on whether to hold interest rates at their current level of 5.25pc or raise it higher at next week’s Monetary Policy Committee (MPC) meeting.

The latest jobs market figures will not help, with data on pay and on employment pointing in different directions.

Pushing Bailey and his colleagues towards another increase in rates is wage growth. Average earnings in the three months to July were up 8.5pc on the year, the highest level seen in more than two decades excluding the pandemic when furlough distorted the data.

The strong wage growth points to a strong economy, stoking fears that prices will keep rising.

Yet on the other hand, unemployment is rising rapidly and the number of people falling out of the workforce is spiking at the fastest rate since the pandemic.

This suggests precisely the opposite: that the economy is rapidly weakening as the impact of rapid rate rises finally takes effect.

The contradictory signals will do nothing to ease the division of the MPC. Last month the nine-strong Monetary Policy Committee was split three ways, with one member voting to hold interest rates at 5pc, six favouring a 0.25 percentage point increase, and two pushing for a double-sized jump of half a percentage point.

Wage growth has become arguably the most important factor looked at by the Bank in recent months when deciding on interest rates, amid fears that continued large pay rises will embed inflationary pressures.

Last week Sir Jon Cunliffe, a deputy governor, told MPs: “In June this year we raised rates by 0.5 percentage points. That was in the light of a 0.5 percentage point upside surprise on private sector pay and a surprise on service price inflation. These are things that the committee has said indicate persistence [in inflation].”

At 8.5pc, the pace of pay growth is now far stronger than the 6.8pc surprise the MPC contended with at its June meeting.

Continued inflation means workers have cause to push for even more pay rises. Although wages are now at last rising more quickly than prices, in real terms the typical pay packet is still noticeably smaller than before the inflation crisis began.

Average earnings are around £19 a week lower than they were in December 2021 after adjusting for inflation. This suggests staff will keep on pushing for a restoration of their earning power.

This will encourage the Bank to raise rates higher to stamp out this inflationary pressure by making continued pay rises simply unaffordable for many businesses.

However, wage growth is just one part of the picture. Elsewhere, there are signs that past rate rises are now beginning to take effect.

Back in June, when Sir Jon was stung by the surprise jump in pay, the Bank could also see that unemployment was low, at 3.8pc, and falling. The jobs market looked strong – a worrying sign for further pay growth and thus inflation.

However, unemployment now stands at 4.3pc and has been steadily increasing over the last three months.

The latest figures show unemployment increased by 159,000, the sharpest rise in joblessness since late 2020 when the economy was heading back into lockdown.

Meanwhile, the number of people in work dropped by 207,000 in the sharpest fall on record outside of a recession.

“This is the clearest sign yet that the Bank of England’s rate rising cycle is starting to cool the jobs market,” said Hannah Slaughter, a senior economist at the Resolution Foundation.

Worse may be to come: employers have been frenziedly hiring in recent years, sending advertised job vacancies to a record high of more than 1.3 million in May last year.

However, the number of posts available has been steadily declining for months and has now dropped below one million for the first time in almost two years.

All of this pushes in the other direction, telling officials that the jobs market is weakening as interest rates take the wind out of the economy’s sails. To take rates higher may risk doing unnecessary damage.

There is yet another factor muddying the waters: the rise in the number of people who are inactive – of working age but neither in work nor looking for work. There are now 8.8 million inactive people, up almost 63,000 on the quarter.

Some of these are students who in time will be expected to enter the jobs market with extra skills.

But others may never be seen at work again. Just 1.7 million – fewer than one in every five inactive people – say they would like a job, the lowest level on records dating back 30 years.

The number citing long-term sickness as their reason for leaving the jobs market continues to rise, up by more than 49,000 to hit a new record high of 2.6 million.

This suggests a smaller pool of people are potentially available to work – again, bad news for wages and prices from the Bank’s perspective.

Compounding this messy picture is a more fundamental problem: the jobs market data is all very backward-looking.

It takes time for companies to make decisions on hiring and firing. Recruitment is slow. Pay decisions are generally only made once per year.

The latest figures therefore represent just a snapshot of the labour market – and one that could already be out of date.

Interest rate changes have their most powerful effect on the economy over 18 to 24 months. This raises the risk that any decision made by MPC based on the latest data will be out of date already and fail to take account of the ongoing impact of rate changes announced months earlier.

Officials are aware of this but reach diverging conclusions nonetheless.

Catherine Mann, one of the two policymakers who voted for a half-point rise in rates last month, argues that it is less dangerous to raise rates too much than to do too little.

“The risk of tightening too little is more salient,” she said this week, noting that services inflation – which is heavily influenced by wages – appears to be worryingly persistent.

By contrast Swati Dhingra, the MPC member who has voted to hold rates steady at every meeting since December, last week said: “There is a growing risk of over-tightening.”

Huw Pill, the Bank’s chief economist, has also raised concerns about doing unnecessary damage.

Meanwhile, Sarah Breeden, who will replace Sir Jon on the MPC from November, sees risks in both directions.

“I think the challenge right now is that wages are high and rising and there is a real risk that the second-round effects mean that this inflation becomes embedded,” she told MPs.

However, she described the UK economy as “weak” and said growth would be “relatively flat” over “the next couple of years” as interest rate rises start to bite.

Policymakers are trying to tread a fine line between keeping a lid on inflation and supporting growth.

It is a challenging task at the best of times, not helped when the data on the jobs dashboard is pointing in different directions. Expect hard fought arguments on all sides when the MPC meets again next Thursday.