Recent UK data releases have further boosted the probability of a November rate hike while suggesting that the accompanying Inflation Report will signal a need for additional policy tightening.
Whole-economy unit labour costs (ULC) rose by 2.4% in the year to the second quarter of 2017, far above a Bank of England staff estimate of 1.0% in the August Inflation Report. The MPC then expected ULC growth of below 2% in both 2017 and 2018, justifying its forecast of a slow return of inflation to the 2% target as import price pressures faded. A major reassessment is now required.
The overshoot in ULC growth relative to the Bank staff estimate reflects a stronger-than-expected rise in non-wage labour costs and weaker-than-expected productivity performance. Non-wage costs (i.e. “employers’ social contributions”) per employee rose by 7.1% in the year to the second quarter, apparently driven by pensions. Whole-economy output per hour, meanwhile, fell by 0.3% in the year to the second quarter versus an MPC “key judgement” of growth of just under 0.5%.
ULC growth of 2.4% in the second quarter was down from an upwardly-revised 3.5% in the first quarter. The latter number incorporated a rise in employers’ national insurance contributions from April 2016 associated with the introduction of the single-tier state pension. This increase dropped out of the year-on-year comparison in the second quarter.
Second-quarter ULC growth of 2.4% is arguably understated because it does not take account of the apprenticeship levy introduced in April. The levy is forecast by the OBR to raise £2.7 billion in 2017-18, equivalent to 0.25% of total employee compensation.
A November rate hike could, in theory, be derailed by a weak preliminary estimate of third-quarter GDP growth to be released on 25 October. August activity data released today, however, suggest that GDP will be reported to have risen by 0.3-0.4% from the second quarter, i.e. no lower than the Bank staff estimate of 0.3% at the time of the September MPC meeting.
The key release was services turnover, which receives little attention but is an input to services output, an August number for which will be reported at the same time as third-quarter GDP. August turnover along with previously-released retail sales suggest that services output more than reversed a 0.2% July fall. Incorporating industrial and construction output for August also released today, the level of GDP in August may have been 0.3-0.4% above the second-quarter level.
The ONS will have limited information about September activity when it releases the third-quarter GDP estimate, so will rely partly on statistical extrapolation. Assuming a further 0.1% monthly GDP rise in September, implied third-quarter growth would be 0.3-0.4%.