UK jobs report underlines case for Bank of England to hold fire on rate hikes

The UK jobs report out Tuesday (19 May) underlined why the Bank of England should not be in a rush to raise rates as a result of the Iran war inflation shock, though the key test for market expectations for tightening may be tomorrow's CPI inflation report.

Data, which showed the unemployment rate rising to 5.0% from 4.9% and a sharp downturn in payrolls, highlights how this supply shock is not a repeat of the 2022 inflation dynamic, in which ample demand and labour market tightness fuelled second-order inflation pressures.

First, jobs are being destroyed. Payrolls declined by 100k in April, after a decline of 28k in March, which was revised up from a smaller decline. The drop in April payrolls was the single biggest decline since the pandemic in May 2020. Vacancies also plunged 28k to 705k, which is a five-year low.

This is feeding into wage growth cooling sharply. Three-month annualised change in private pay rose just +0.6%, the weakest since 2015. 

Taken together, it really raises doubts about whether the Bank of England needs to raise rates to combat inflation. 

What does it mean for the Bank of England?

Following the BoE’ decision in April I noted that while the Bank is mindful of inflation recent labour market data has softened and does not suggest second order effects of wage price spirals. This is not 2022 – a fact stressed by Governor Andrew Bailey in his remarks accompanying the April meeting; the labour market is in a far worse place, workers lack the bargaining power they had then, rates are already restrictive not at the zero lower bound, and we don't have the huge post-pandemic demand impulse that unleashed prices and inflation expectations became unanchored.  

The latest report on employment further underscores this assumption in terms of the likelihood of second-order inflation pressures. In April I also noted that commentary from the MPC members indicated there seems to be a majority within the committee who are not in a rush to raise rates as quickly or as aggressively as the gilt futures markets implied.

However, I also noted that the key test will be the pass-through to CPI inflation figures – those are out tomorrow morning and are expected to rise as high as 3.7% for April, having jumped from 3.0% in February to 3.3% in March. These numbers will be crucial to whether the Bank moves to raise rates in June. I suspect a majority of MPC members are keen to hold fire until more is known, but we cannot rule out a hike next month with little signs of progress on the Strait of Hormuz.

The Bank of England ought to look through this temporary supply shock and wait a while longer before it thinks about thinks about raising rates. While inflation has ticked up due to motor fuel prices, we need more time to see the impact on broader inflationary pressures and second-round effects. Business surveys meanwhile paint a mixed picture with the Bank's own Decision Maker Panel not suggesting much pass-through. It will be harder for firms to pass on higher costs than it was in 2022 - by hiking the Bank risks fighting the last war. Governor Bailey seems aware of this risk.