Supply and spare capacity

3.1 Labour market: developments and prospects

Recent developments

Since the February Report, the unemployment rate has fallen slightly, to 3.9% in the three months to February, as expected (Chart 3.1). That is a little below the MPC’s assessment of the equilibrium rate of unemployment — of 4¼% — that would be consistent with inflation at the target. A range of other indicators also point to labour market conditions remaining tight (Table 3.A).

Employment growth has been strong in recent months. Employment grew by 0.5% in the three months to February, and is expected to have grown by 0.4% in Q1 as a whole. This compares with a projection of 0.2% growth in the February Report. Over much of the past two years, employment growth has mainly reflected more full-time employees (Chart 3.2).

Alongside the rise in employment, the participation rate increased relative to three months ago — to 64.0% — and by more than had been projected. Part of this reflected revisions due to a reweighting of the Labour Force Survey (LFS) to take into account the latest population data. Much of the increase in participation in the labour market relative to three months ago was accounted for by those aged 50 and over. Participation is projected to remain at around current rates over the three years of the forecast period. This reflects the net result of two offsetting factors: the ageing of the population, which will tend to pull down on participation rates; and increases in participation within older age groups.

The strength in employment growth in recent months has occurred alongside soft demand growth, and has therefore been associated with sluggish productivity growth (Section 3.2). The employment strength contrasts with the weakness in investment growth (Section 2).

Brexit-related uncertainty is weighing on both investment and employment. Decisions to hire and invest both involve a degree of commitment, which means that there is value in postponing them in the face of uncertainty. However, this uncertainty is likely to be weighing more heavily on investment than employment, given that decisions about employment tend to be less costly to reverse.¹

Responses to the Bank’s latest Decision Maker Panel (DMP) Survey are consistent with this: companies that report Brexit as a top-three concern have seen employment grow by slightly less (Chart 3.3), and investment grow by appreciably less, than those who do not. The size of this effect on aggregate employment growth is uncertain: analysis by Bank staff suggests that this could have reduced private sector employment by anywhere between ½% and 2% since the EU referendum, compared with an estimated 6%–14% reduction in investment from Brexit uncertainty. Companies that report that they have reduced employment because of Brexit have tended to do so through lower hiring rather than lay-offs (Chart 3.4).

The changing composition of new hires also provides evidence of how uncertainty appears to be affecting employment decisions. In the past, increases in uncertainty have tended to be associated with a greater proportion of temporary new staff placements relative to those that are permanent.² The REC survey suggests this relationship has continued recently.

The strength of employment growth relative to investment growth does not appear to reflect individual firms employing more labour as a substitute for investment, according to responses to the latest DMP Survey. It is possible, however, that compared with the past, companies for which production is more labour-intensive have been growing more quickly relative to those for which it is more capital-intensive. To the extent that this has been the case, it might have contributed to the strength in employment growth relative to that of investment.

Near-term prospects

Most employment surveys have softened somewhat since the start of the year. In particular, the employment components of the monthly IHS Markit/CIPS and REC surveys have weakened materially (Chart 3.5). This might reflect soft GDP growth (Section 2). It may also be a consequence of companies finding it hard to recruit. Indicators of labour demand have remained strong — for example, the number of vacancies continues to be above historical levels — and that has been associated with surveys suggesting that recruitment difficulties remain elevated (Table 3.A). Further, the KPMG/REC Report on Jobs found that staff availability had continued to decline sharply, with recruiters citing Brexit related uncertainty, fewer EU workers and a high employment rate as factors.

The recent softening in the surveys stands in contrast to the official estimates of strong employment growth in the three months to February, although such divergences are not uncommon. Both the employment surveys and the LFS are subject to sampling variability that may cause estimates to differ from actual employment growth. The LFS response rate has been declining in recent years which may have increased this variability.³ However, the surveys may be erratically weak and recover as Brexit uncertainty wanes. For example, immediately after the EU referendum, a number of surveys fell sharply, while the official data they relate to did not.

• Notes

  ¹ See, for example, Vlieghe, G (2019), ‘The economic outlook: fading global tailwinds, intensifying Brexit headwinds’.

  ² See Broadbent, B (2016), ‘Uncertain times’.

  ³ ONS (2018), ‘Labour Force Survey performance and quality monitoring report: October to December 2018’.

3.2 The outlook for potential supply

In its annual reassessment of supply-side conditions in February, the MPC judged that 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 remain modest, averaging around 1½% in the central projection.

Labour supply growth was projected to be subdued relative to recent years (Table 3.B), with almost all of it expected to come from population growth. The MPC’s forecast is conditioned on the ONS’s principal population projection, published in 2017. The projection implies a further slowing in net migration over the next few years, to 189,000 in the year to 2021 Q2 (Chart 3.6). In the latest data, net migration was 283,000 in the year to 2018 Q3, somewhat higher than the ONS principal projection. Net migration from the EU continued to decline as it has done since the referendum, reflecting both lower inflows to the UK and increased outflows. Intelligence from the Bank’s Agents suggests that this decline in EU migration has exacerbated labour shortages in some sectors.⁴

In February, the MPC revised down its near-term projections for productivity growth. Over the past decade, much of the weakness in UK potential supply growth relative to the decade prior to the crisis can be accounted for by slower productivity growth (Table 3.B), which has often been weaker than projected (Box 6). Since February, productivity growth has remained weak: in the year to 2019 Q1 it is estimated to have increased by 0.7% on a per-head basis and decreased by 0.1% when measured per hour (Chart 3.7).

In the MPC’s projections, four-quarter potential productivity growth picks up gradually to around 1% towards the end of the forecast period (Section 5). The improvement in productivity growth is supported by higher investment, and also reflects an expected increase in the efficiency with which capital and labour are used to produce output — total factor productivity growth. That could be boosted by higher research and development expenditure over recent years.

• Notes

  4 Agents’ summary of business conditions 2019 Q1.

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