UK labour market tightening stalled in early 2015: employment and aggregate hours worked fell by 0.2% between the first and second quarters, while the unemployment rate edged up from 5.5% to 5.6%.
The issue for the MPC is whether this setback is temporary, reflecting slower first-quarter GDP expansion and pre-election hiring caution, or indicates a weaker growth trend and / or stepped-up productivity performance.
Vacancies, a leading indicator of employment, provide tentative support for the former hypothesis. The official vacancies series (a three-month moving average) declined between February and May but recovered in June – see first chart. Similarly, claimant count unemployment – which now includes those transitioned to universal credit – fell by 4,900 in July, the most since April.
Annual weekly earnings growth (three-month average) declined from 3.2% in May to 2.4% in June, reflecting a slowdown in volatile bonuses. The ex bonus measure was stable at 2.8%, with the private sector component at 3.3%. With average weekly hours down slightly from a year ago, hourly ex bonus earnings growth rose to 3.1%, a four-year high – second chart.
Investors have been fearful of the market fallout from a rise in US official rates in September or December. In the event, it has been the unfixing of another central bank-controlled price – the RMB / US dollar exchange rate – that has triggered turmoil.
The official explanation is that the change to the daily fixing mechanism is intended to allow the currency to be more market-driven. The question is what is meant by “more”. The only formal constraint on depreciation imposed by the new mechanism is that onshore spot can fall by no more than 2% per day. If the market were allowed free rein, the currency would probably move 10-20% lower in short order, causing major global financial and economic disruption.
The majority view is that the authorities will step in to prevent a decline of more than about 5%, suggesting that the market-driven regime will last only one more day, given a 3.5% drop over Tuesday-Wednesday. A larger fall is deemed unlikely because:
A big devaluation, if it were desired, would have occurred instantly.
A lower currency is unlikely to boost exports and growth much, if at all, because of parallel depreciations of EM competitor currencies and negative global financial / economic spillovers.
The authorities have stepped up fiscal easing recently and are probably relying on this, rather than an export boost, to revive growth.
A big fall would displease the US administration, threatening a veto of RMB inclusion in the SDR – a key official goal.
A big decline would run counter to desired economic “rebalancing” from exports / low value-added manufacturing to consumption / services.
The majority view is plausible but confidence in the authorities has been shaken by the recent stock market debacle. There is also concern that the decision to unpeg the currency is the result of an internal power struggle and there may not be a coherent longer-term plan.
The currency announcement has overshadowed economic / monetary data suggesting that growth remains weak but has recovered since early 2015:
Annual industrial output growth was 6.0% in July versus 6.8% in June but the decline reflected an unfavourable base effect. Output was unchanged month-on-month in July following a large 1.5% gain in June. Six-month growth has revived to 3.5% from a low of 1.8% in March – see first chart*.
Housing demand continues to recover, with sales volume up by an annual 21% in July.
Six-month growth of real (i.e. CPI-adjusted) M2 rose to its highest since October 2012 in July, partly reflecting “stock market QE” – officially-ordered bank loans to other financial institutions to fund price-keeping operations.
Core CPI inflation – excluding food and energy – was stable at 1.7% in July; producer price deflation mainly reflects commodity price weakness – second chart.
Global equity markets may remain under pressure until the RMB stabilises and policy intentions become clearer. The liquidity backdrop, however, is still supportive, with global real money growth – on both narrow and broad definitions – respectable and well ahead of output expansion. Bears are making comparisons with the 1997-98 Asian currency crisis but this actually proved positive for global stocks as Fed tightening was aborted – the MSCI All-Country World index rose by 12% in US dollar terms in the 12 months following the breaking of the Thai baht / dollar peg on 2 July 1997.
*Based on World Bank seasonally-adjusted level data.
Bank of England Governor Mark Carney managed to suppress hawkish dissent at the August MPC meeting but the latest Inflation Report forecast creates a strong presumption in favour of an interest rate rise before year-end.
It was always unlikely that more than one or two mavericks would defy Governor Carney’s recent signal that it would be premature to act before “the turn of the year” by voting for a hike in August. The silent hawks got their revenge by pushing through a rise in the inflation forecast two to three years out, putting them in a solid position to carry the day in November, barring downside data surprises or adverse financial market developments.
The best summary measure of the MPC’s collective view is the mean forecast for inflation in two years’ time based on unchanged policy. This was raised sharply from 2.35% in May to 2.60% in August. The 0.6 percentage point overshoot relative to the target is the largest positive deviation in the MPC’s 18-year history and sends a clear signal that rates need to start rising soon if the path back to neutral is to be “gentle”, as Governor Carney has promised.
Sterling initially fell on today’s news, with the market giving more weight to the 8-1 August vote than the hawkish forecast – wrongly, on the assessment here.
(A monetarist gripe: The structure of the Inflation Report has been changed, with a previous chapter on “Money and asset prices” replaced with “Global economic and financial developments”. There is no reference to money anywhere in the book – striking even by the Bank’s standards.)
A post in February suggested that deflation worries were overblown and that “core” consumer price inflation would remain stable in 2015. Recent news has played to this script.
Core CPI inflation, indeed, has risen slightly since the start of the year in the US, Japan, the Eurozone and China – see first chart. The main exception to the trend has been the UK, where a 10% increase in sterling’s effective index since end-2013 has acted as a significant dampener.
US core CPI inflation is under upward pressure from rising growth of housing rents – see yesterday’s post. Weakness in goods prices, meanwhile, may abate: producer price inflation of core consumer goods is well above the corresponding CPI rate and has moved higher recently – second chart.
Japanese core CPI inflation is underpinned by rising pay growth: the annual increase in scheduled wages climbed further in June, with a change in the timing of bonus payments explaining a fall in total pay – third chart.
The uptick in core CPI inflation in China contrasts with continued weakness in producer prices, suggesting that the latter reflects commodity price falls, a rising exchange rate and the economy rebalancing away from heavy industry, rather than significantly restrictive monetary conditions.
Bond market inflation expectations collapsed in tandem with commodity prices in late 2014 as the deflation scare took hold. The recent response to further commodity price weakness has been much smaller, suggesting market recognition of core inflation resilience – fourth chart.
Friday’s news of a smaller-than-expected rise in the employment cost index (ECI) in the second quarter has cast doubt on the prospect of an early Fed rate move. Annual growth in the ECI wages and salaries component fell from 2.6% to 2.1%, exactly reversing a first-quarter increase, despite evidence from job openings and other indicators of a tight labour market – see first chart.
The details, however, reveal that the decline was entirely due to a fall in wage growth in incentive-paid service occupations, following a sharp rise in the first quarter. Excluding all incentive-paid occupations, the annual ECI wage increase was stable, at 2.0%. In goods-producing industries, annual growth including incentive pay rose to 2.4%, a seven-year high – second chart.
The volatility of incentive pay suggests averaging the first and second quarter results. Annual growth of total pay was 2.3% in the first half, up from 2.1% in the second half of 2014.
The second-quarter setback, therefore, is unlikely to be a deal-breaker for a September Fed move, although this will require further solid payrolls growth in July / August and other evidence that recent faster GDP expansion is being sustained.
In other inflation-related news last week, the housing rental vacancy rate fell to its lowest level since 1985 last quarter, suggesting a further pick-up in rental growth – third chart. Actual and imputed rents account for a combined 40% of the core CPI basket (i.e. excluding food and energy).