With the Bank of England resorting to a completely data-dependent stance, the focus for rates markets is now squarely on the data.
Although the BoE did partially endorse a higher policy path with their latest round of economic forecasts, it also raised the bar for any hawkish surprises in the data. This left an array of Bank Rate forecasts amongst sell-side economists and it is in this context that today’s labour market data, the first real test of the Bank’s latest forecasts, printed.
It is notable that whilst the March data contained a modest beat for the 3m/3m employment change, this was offset however by a marginally negative surprise in earnings, a surprise uptick in unemployment for the second month in a row despite sampling adjustments suggesting otherwise, and a substantial drop in April’s payrolls. In combination with more recent measures which show pay growth is cooling substantially, today’s data highlights that upstream pressures are starting to filter through, leading to a cooling in the UK labour market that is consistent with forward-looking survey data.
While only the first of two labour market releases ahead of the BoE’s next decision on June 22nd, the softer composition of today’s labour market report supports our view that Bank Rate is currently at its terminal level at 4.5%.
With forward-looking indicators for the UK labour market showing that employment conditions were beginning to soften for some time now, there had been an expectation that it was only a matter of time before this began to show up in the hard data. The latest REC report of jobs has seen its balance for permanent placements sit below zero since October 2022, with April’s reading printing at -5.9. In addition, composite PMI employment sub-indices have also recently shown a stagnation in employment intentions. One of the surprises of recent releases, therefore, has been the robustness of the hard data when it is published. As a result, many forecasters upgraded their expectations for labour market strength, even in the face of the BoE’s rapid monetary tightening over the current hiking cycle. Even the BoE did as such in May’s Monetary Policy Report. Specifically, the Bank of England in their most recent forecasts expects unemployment to remain at 3.8% in both Q1 and Q2, with the Q2 forecast having been revised down from 4.1% expected at the February meeting. It is in this context then that unemployment unexpectedly ticked up in March, from 3.8% to 3.9%, and is now seen to be running above BoE projections, and against pre-release expectations for this measure to remain steady.
Perhaps more startlingly, the more timely measure for the change in payrolled employees showed a drop of 136k, despite market expectations for this measure to actually increase.
Admittedly, the PAYE measure of employment is incredibly noisy on a monthly basis, but the fact that it is now consistent with the anecdotal evidence from firms and the survey indicators suggests that this may be a start of a trend. It is also worthwhile noting that the 3m/3m employment change did show a slight gain of 13k, taking the March figure to 182k. However, given this is one of the more backwards looking measures in this morning’s release, the marginal upswing does little to detract from the overall signs that the UK labour market is beginning to slow, and possibly quite rapidly.
Despite the slowdown in headline numbers for employment, the same cannot yet be said for wage data, which continues to print strong. Average weekly earnings showed an increase of 5.8% on a 3m/YoY basis for March, which was in line with expectations, and flat on a downwardly revised number for February. A similar story was true once excluding bonuses, where the data showed a fractional uptick of 0.1pp, leaving the increase in weekly earnings ex-bonus at 6.7%, albeit this was below pre-release expectations for this to increase even faster at 6.8% 3m/YoY. However, the measurement of the data is releasing false signals in our view.
Our calculations of the more timely 3m/3m annualised measure of average weekly earnings ex bonus show that pay growth continued to cool in March, down from 6.2% in February to 5.87%.
This has been a consistent trend since November, when the measure peaked at 8%, and shows that the headline measure is on track to fall to 5% in 2023 as expected by the BoE or even below. Furthermore, the PAYE measure of median pay, once smoothed out and annualised in a similar manner, suggests that wage growth continued to trend lower in April, consistent with the signal from employers that wage settlements are likely to average much lower this year than last.
Forward-looking PAYE data points to a continued moderation in core pay growth, consistent with survey indicators
Whilst it is often observed that monetary policy acts with long and variable lags, in our view this latest release points to a labour market finally beginning to show the signs of slowdown in response to BoE hiking, and supports the case for a hold in rates at 4.50% at the June MPC meeting.
Given the recent upgrades to expectations in the latest BoE forecasts, we like other sell-side economists have noted that the goalposts have shifted for upcoming releases, with an increased likelihood that we would see weaker than forecast data. For a BoE that once again signalled its data dependence, this is strongly suggestive that a hold in rates will be the likely outcome of upcoming policy meetings. Whilst it is probable that the BoE will choose to maintain a data dependant stance and not explicitly signal any termination of their hiking cycle, the rapid fall in CPI that will be seen in coming months as last year’s energy price shock drops out of the consumption basket, combined with signs of a labour market that is not only slowing, but slowing faster than anticipated, now shifts the balance of risk towards overtightening. Markets appear to be of a similar opinion this morning, with expectations for BoE hiking being notably trimmed.
The OIS implied probability for a hike in June has fallen by 10% this morning to 73%, and the anticipated level for the peak in Bank Rate has also declined by around 7bp.
This paring of rate expectations has in turn led cable lower, with the pair falling a third of a percentage point in response to this morning’s data. With several more releases yet to be seen before the June meeting, however, rates markets are not ready to capitulate and align with our view for no further hikes quite yet. However, although this is just a single data release, we think the direction of travel is now set. Confirmation in upcoming CPI prints and a further labour market release just before the June MPC meeting looks likely to see a moderation of rate expectations by markets will provide a drag on sterling over the next few weeks as a result.
Simon Harvey, Head of FX Analysis
Nick Rees, FX Market Analyst