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Is the UK MPC about to make another policy mistake?

Posted on Wednesday, March 21, 2018 at 12:58PM by Registered CommenterSimon Ward | CommentsPost a Comment

Today’s UK labour market release is likely to cement MPC plans to hike rates again in May. Monetary trends suggest that the Committee should hold off.

Annual growth of average weekly earnings, smoothed by a three-month moving average, rose to 2.8% in January from an upwardly-revised 2.7% in December. Growth of regular earnings – excluding bonuses – was lower at 2.6%, though moved up to 2.8% on a single-month basis in January. Pay trends appear slightly stronger than the MPC expected at the time of the February Inflation Report, which suggested that regular earnings growth would average around 2.75% during the first half of 2018.

MPC hawks will also take note of a rebound in aggregate hours worked in the three months to January after a surprise drop in the prior three months, suggesting that a pick-up in growth of productivity (i.e. output per hour) in the second half of 2017 was temporary. The unemployment rate, meanwhile, returned to its recent low of 4.3% in the three months to January.

Why, then, should the MPC delay hiking again? Current labour market conditions are a lagged reflection of above-trend economic growth in 2016-17, which was signalled by strong monetary trends through late 2016. A subsequent significant monetary slowdown argues that economic prospects have deteriorated, implying that labour market strength will ebb and medium-term inflation risks are receding.

Annual growth rates of non-financial narrow (M1) and broad (M4) money fell to 5.3% and 3.7% respectively in January, the lowest since 2012 – see first chart. Trends appear to have weakened further since the November rate hike, with monthly growth of the two aggregates averaging only 0.1% in December / January.

The case for the MPC holding off, it should be emphasised, is unconnected to yesterday’s news that consumer price inflation dropped to 2.7% in February from 3.0% in January. Inflation is expected here to remain around its February level through late 2018. The overshoot, however, is a consequence of past policy laxity relative to monetary and economic conditions – belated remedial action risks compounding the error.

As previously discussed, weaker monetary trends have already been reflected in a slowdown in nominal GDP, annual growth of which subsided to 3.2% in the fourth quarter, compared with a peak of 5.2% in the fourth quarter of 2016. Today’s public finances release suggests that this slowdown is feeding through to government receipts, casting doubt on Chancellor Hammond’s optimism about fiscal headroom in last week’s Spring Statement – second chart.

Softer receipts hint that labour market strength may be peaking, as does a fall in outstanding vacancies in the three months to February – the first decline since June 2017.

Today’s CBI industrial trends survey for March, meanwhile, was weak, with the output expectations balance down further and the balance reporting more-than-adequate finished goods stock levels surging – third chart.

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