Inflationary risks from the UK labour market continue to increase. Today’s statistics show a further decline in labour availability, continued poor productivity performance and rising wage pressures.
The unemployment rate fell to 5.7% over October-December, the lowest since 2008 and down from 7.9% at the time of the last general election in May 2010. The short-term unemployment rate, measuring those out of work for six months or less, dropped to 2.8%, the lowest on record in data extending back to 1992 – see first chart.
The more timely claimant count, meanwhile, dropped by a whopping 39k in January, suggesting that the overall unemployment rate will maintain its recent pace of decline of about 0.1 percentage point per month – the Bank of England, by contrast, expects a slower fall.
The implication of a growing labour shortage is supported by a further rise in the stock of unfilled vacancies to a record in data back to 2001.
The Bank of England last year claimed that rapid labour supply expansion would head off a shortage of workers. The labour force, however, expanded by only 0.4% in the year to the fourth quarter, well below the average annual growth rate of 0.9% since 2005 – second chart.
Bonus payments pushed up the annual growth rate of average weekly earnings to 2.4% in December but regular pay expansion eased back to 1.6% from 1.7% in November. Private regular earnings, however, increased at a 3.3% annualised rate between the third and fourth quarters, suggesting a pick-up in annual growth in early 2015 – third chart.
Productivity performance, meanwhile, remains dismal. Aggregate hours worked in the economy rose by 0.8% between the third and fourth quarters, exceeding the currently-estimated 0.5% rise in GDP. Flat productivity and a slow labour force rise suggest that trend GDP expansion is much weaker than implied by the Bank of England’s rosy forecast of strong medium-term growth coupled with sustained low inflation.
A post in April last year described an economic model of UK voting intentions. This model suggested that the Conservatives would move into a 1-2 percentage point lead over Labour by the May 2015 general election, based on a plausible economic scenario. Updating the inputs, it continues to predict a 2 point Tory advantage by May but indicates that the gap would rise to 6 points by end-2015 in the absence of an election, as the economic backdrop continues to brighten. Conservative hopes of victory rest on persuading voters to give them credit for prospective as well as current good news.
The model is designed to predict the poll differential between the main government and opposition parties based on economic factors. It was estimated on ICM-Guardian poll data extending back to 1984. The poll differential depends positively on average earnings growth and house price inflation, and negatively on the unemployment rate, inflation and interest rates (Bank rate). More details are available in the previous post.
The Conservative-Labour differential swung from -3 percentage points in the January ICM-Guardian poll to +4 points in the February poll released this week. The model suggests that the latter result is an outlier and the “true” differential is currently -1 point – see chart. The Tories, however, are predicted to move into a 2 point lead by May, based on key assumptions that average earnings growth rises to 2.5% by then and consumer price inflation remains below 0.5%.
The problem for Conservative strategists is that the earnings pick-up may be occurring too late to swing the election result. The Bank of England expects earnings growth to rise further to 3.5% by late 2015. With inflation projected to remain low and unemployment to continue to decline, the Bank’s forecast implies that the Tory lead would widen to 6 points by end-2015 in the absence of an election, according to the model. A 6 point advantage in May would ensure a return to power.
The Conservatives are finally benefiting from an improving economy but their challenge is to convince voters that the recent recovery in real earnings is the start of a sustained upswing, for which they should receive electoral credit now.
Forecast changes in the February Inflation Report look internally inconsistent.
The MPC slashed its near-term inflation forecast to take account of recent commodity price weakness, with the annual CPI change now expected to fall to about zero in the second and third quarters of 2015. Surprisingly, it also lowered its medium-term projection: inflation in the first quarter of 2017, for example, is now forecast at 2.2% assuming unchanged policy, down from 2.4% in November.
The latter reduction is inconsistent with a significant downward revision to the MPC’s estimates of current and future spare capacity. Slack is estimated to be only about 0.5% of GDP at present, down from 1% in November, and is forecast to be eliminated within 18 months, versus two to three years previously.
Earlier elimination of spare capacity contributes to a stronger pick-up in average earnings growth, which reaches 3.5% and 4% in the fourth quarters of 2015 and 2016 respectively, a quarter-point higher than in November in both cases. With productivity assumptions little changed, unit labour cost growth climbs to 2% in late 2015 and 2.75% a year later.
Unit labour cost growth of 2.75% by late 2016 is incompatible with inflation remaining close to 2% in 2017, barring a major profits squeeze or further fall in import costs. The MPC may resolve this contradiction by raising its medium-term inflation forecast in May – after the general election.
Japanese monetary trends remain strong, suggesting upside risk to the consensus forecast of 1.2% GDP growth in 2015.
The six-month change in M1, M2 and M3 peaked in late 2013 and fell sharply through July 2014. The real-terms change turned negative from April, when a rise in the sales tax from 5% to 8% boosted consumer prices by 2.1%*. This contraction was reflected in falls in GDP in the second and third quarters – see first chart.
Money measures, however, have rebounded strongly since July, while the sales tax hike dropped out of the six-month inflation rate in October. Six-month real money growth, therefore, is back at levels consistent with solid economic expansion. Industrial output rose by 1.7% between the third and fourth quarters while next week’s GDP release may report an increase of about 1%, or 4% annualised.
Also notable is a continued firming of wage trends, consistent with evidence of a tight labour market. Total cash earnings at firms with 30 or more employees rose by an annual 2.5% in December, reflecting a 3.4% increase in winter bonuses. More significantly, growth in scheduled earnings (i.e. excluding bonuses and overtime) climbed to 1.2%, a level matched or exceeded in only three months since 1997. With headline consumer price inflation on course to fall to zero in the spring as a result of oil and tax effects, annual real wage growth should soon be running at 1-2% – second chart.
*Bank of Japan estimate.
The global economy is dominated by the G7 countries and the seven largest emerging economies, or “E7”*. Six-month growth of industrial output in these fourteen economies rose to an estimated 2.3%, or 4.7% annualised, in December**. The longer leading indicator calculated here suggests that the recent upswing will extend through the first half of 2015, at least – see first chart.
The recovery in G7 plus E7 growth from a low in August 2014 reflects stronger expansion in both groups. Growth remains significantly higher in the E7 than G7, although the current gap is below its average since 2010 – second chart.
The G7 and E7 aggregates are calculated from World Bank country data on industrial output in constant (2005) US dollars. On this measurement, E7 industrial output now exceeds the G7 level. The ratio of E7 to G7 output has risen from 49% at the start of 2005 to 100% in September 2014 and 101% by December – third chart.
E7 / G7 convergence reflects enormous growth of industrial output in China. China now accounts for 62% of E7 output and 31% of the G7 plus E7 aggregate. The latter compares with 22% for the US. On the World Bank figures, Chinese industrial output surpassed the US level as long ago as 2009. Chinese output has risen by a cumulative 228% since January 2005 versus 34% for the rest of the E7 and only 4% for the G7.
*BRIC plus Korea, Indonesia and Mexico. The G7 plus E7 countries account for three-quarters of global industrial output, according to World Bank data.
**80% data coverage. December output is assumed to be unchanged from November for missing countries.