TalkingEconomics: UK summary July 2015
Labour market indicators in the UK suggest supply is becoming tight as corresponding wage data is now accelerating. Despite this, the Bank of England (BoE) remains relaxed.
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This may change later this year, but with inflation barely above zero and concerns over Greece and the euro, it does not seem feasible for the Bank to hike interest rates in 2015.
Warning bells are ringing
Evidence is mounting that the UK economy is running out of spare capacity. Most indicators point to a shortage of labour and early signs of significant wage inflation.
These include data such as the unemployment rate (which is now at its lowest level since the summer of 2008 at 5.5% in April) and survey data which show that companies are finding it increasingly difficult to hire.
This suggests that firms may have to compete more with each other to recruit and retain staff. The result should be an acceleration in wage growth, something we are finally beginning to see.
Wage growth arrives
For the economy as a whole, average nominal wages grew by 2.7% in the three months to April compared to the same period a year earlier - the fastest pace of annual wage growth for three years - and even more impressive when compared to current inflation of just 0.1% year-on-year.
Industry-level data highlights the pressure in the labour force more starkly: half of the UK’s sectors have, in the last year, increased pay by at least the average growth rate of the five years preceding the financial crisis. Wage growth inflation has been the highest in those industries that are more labour intensive while it is far slower in those sectors where labour intensity is lower.
Bank of England remains relaxed….for now
The BoE’s reasoning behind its cautious approach to interest rates centres on productivity growth. Since 2008, productivity growth has fallen to zero and BoE staff expect this to recover in time.
If this happens, then as the economy continues to grow, the productivity recovery would reduce the need to hire many more workers, which would minimise additional pressure on unit wage costs or inflation, and thus reduce the need to hike interest rates.
However, if productivity fails to recover, then firms will need to increase hiring further, causing wages to pick up. The chance of inflationary pressure, and the need for rate hikes, then rises.
With inflation still below the lower bound of the BoE’s target range, and not forecast to rise above 2% until the end of 2016 (this is our own estimate – the BoE sees inflation staying below 2% until much later), we believe the first interest rate hike will occur in February 2016 (we pushed this out from November 2015 last month).