Supply and the labour market

In the May Report, the MPC judged that demand and supply had been broadly in balance around the turn of the year, but that a small margin of excess supply had begun to emerge in 2019. That assessment, based on the evidence from both statistical filtering techniques and the components of spare capacity, is little changed. It is consistent with the MPC’s judgement that underlying demand growth has been below potential in the first half of 2019 (Section 2).

The latest data suggest that the labour market remains tight, although employment growth has softened (Table 3.A). As a result, wage growth remains stronger than in recent years. Continued weakness in productivity growth means that unit labour cost growth has picked up, raising domestic inflationary pressures (Section 4).

There are some signs that companies may be operating a little below normal capacity. The CBI survey measure of capacity utilisation, for example, has fallen to below its historical average (Chart 3.1).

The MPC judges that a small margin of excess supply will persist in coming quarters, as underlying demand growth remains below potential (Section 5).

3.1 The labour market

The unemployment rate fell slightly in the three months to May, to 3.8%, a little lower than expected in the May Report (Chart 3.2). That remains below the MPC’s assessment of the equilibrium rate of unemployment — of 4¼% — that would be consistent with inflation at the target in the medium term.

Employment growth has softened in 2019. It was 0.1% in the three months to May, down from 0.5% in the three months to February. The number of employees fell in the latest data, while self-employment rose sharply. The slowdown in overall employment growth may be a consequence of companies finding it harder to recruit, given a smaller pool of available labour. It may also reflect an easing in the demand for labour as underlying GDP growth has slowed (Section 2). The number of vacancies has fallen back a little in recent months (Chart 3.3), and is around 4% lower than its peak in the three months to January. In addition, the REC index of demand for staff fell a little further in 2019 Q2 (Table 3.A).

Alongside the slowing in employment growth, the participation rate fell a little to 63.9% in the three months to May. The participation rate remains high, however, as the proportion of people who want to work has increased within certain demographic groups in recent years. For example, rises in the state pension age, as well as improved health and longevity, have raised the participation rates of older workers.¹

Average hours worked fell back a little in the three months to May. That fall appears to partly reflect the unwinding of the temporary boost to hours in Q1 arising from Brexit-related stockpiling. In particular, average hours worked in the manufacturing sector rose strongly as output in that sector increased. Since then, manufacturing output has fallen back.

Employment growth is projected to remain positive at 0.2% in 2019 Q3, consistent with surveys of employment intentions such as the REC and the Bank’s Agents (Table 3.A). The unemployment rate is expected to be 3.7% (Chart 3.2), as expected at the time of the May Report.

Despite the easing in labour demand and employment growth, the labour market remains tight. For example, some survey measures of recruitment difficulties remain above historical averages. And job-to-job flows — which will, in part, reflect the degree to which employers are competing to hire employees — are close to pre-crisis rates (Table 3.A).

The tightness of the labour market has been associated with faster pay growth. As shown in a wage Phillips curve, lower rates of unemployment over the past year have been accompanied by higher wage growth (Chart 3.4), as companies have paid more to secure employees from a smaller potential pool of labour. Annual growth in whole-economy regular average weekly earnings (AWE) — which excludes bonuses — rose to 3.6% in the three months to May. A small part of that rise may reflect the increase in the National Living Wage in April. Private sector regular pay growth also rose to 3.7%, the fastest rate since 2008.

There are signs that pay growth is likely to stabilise. According to the Bank’s database, median pay settlements in the private sector were around 2½% in the 12 months to June, down slightly from 2¾% in the previous 12 months, and survey indicators of pay growth have edged down in the latest data (Table 3.B). Four-quarter growth in whole-economy AWE regular pay is expected to average around 3½% over the rest of 2019 (Table 3.C).

Although pay growth has risen over the past year, it remains lower than before the financial crisis, despite a lower unemployment rate (Chart 3.4). That is likely to reflect subdued growth in productivity — the amount of output that can be produced per worker — which has reduced the wage rises that companies can afford to offer their employees.

3.2 The outlook for potential supply

In February, in its annual reassessment of supply-side conditions, the MPC judged that annual growth in the potential supply capacity of the economy — which is determined by the quantity of labour available and the amount of output that those in employment can produce — was likely to average a little below 1½%. That is lower than pre-crisis rates, which averaged close to 3%.

Labour supply growth is projected to be subdued relative to recent years although only a little below its pre-crisis average rate (Table 3.D). Almost all of the future increase in labour supply is expected to come from population growth. The MPC’s forecast is conditioned on the ONS’s principal population projection, published in 2017. That projection implied a slowing in net migration. The latest data showed that net migration slowed in 2018 Q4, but remained a little above the ONS projection.

Much of the weakness in UK potential supply growth relative to the decade prior to the crisis can be accounted for by weaker productivity growth (Table 3.D). In February, the MPC revised down its near-term projections for productivity growth, and growth has remained weak since then. It is estimated to have fallen by 0.5% in the year to 2019 Q2 on a per-hour basis, and risen by 0.2% on a per-head basis.

Brexit-related uncertainties appear to have weighed on productivity growth since 2016. That is partly because Brexit appears to have had a negative effect on the output of firms that are more uncertain about the impact on their business. These firms tend to trade more with the EU and to be more productive than average. It may also reflect businesses devoting resources to planning for Brexit. For example, responses to the Decision Maker Panel (DMP) Survey in 2019 Q1 suggested that three quarters of CFOs were spending some time planning for Brexit. Finally, it may also reflect lower investment growth associated with the prolonged period of uncertainty associated with the Brexit process.

As in May, four-quarter productivity growth is projected to pick up to a little above 1% in the second and third years of the forecast (Section 5). The outlook for productivity growth is likely to remain sensitive to the form of the UK’s future trading relationship with the EU.²

• Notes

  1. The effects of demographics on participation and other aspects of the economy are discussed in Saunders, M (2018), ‘Some effects of demographic change on the UK economy’.

  2. For details, see ‘EU withdrawal scenarios and monetary and financial stability: a response to the House of Commons Treasury Committee’.