The labour market and pay

Section 3 of the Inflation Report - August 2018

Labour demand growth remains robust and a very limited degree of slack is left in the economy. Reflecting the tightening in the labour market, indicators of pay growth have been strengthening and pay growth is projected to rise slightly further. That, combined with subdued productivity growth, is contributing to rising domestic cost pressures.

Most indicators suggest that labour demand growth has remained robust and that the labour market is currently tight (Section 3.1). Pay growth has risen over the past year (Section 3.2) and tightness in the labour market is expected to push up pay growth slightly further in coming years (Section 5). In addition to stronger pay growth, unit labour cost growth has been boosted by temporarily weak growth in productivity (Section 3.3). Over coming years, the projected further strengthening in wage growth raises domestic inflationary pressures (Section 4).

3.1 Labour market tightness

During the financial crisis, output fell and unemployment rose, as companies reduced hiring and increased redundancies. The number of additional hours people wanted to work also rose, perhaps in response to a squeeze in their real incomes. Taken together, these factors led to a substantial degree of spare capacity opening up in the labour market over this period. This, in turn, was a significant factor behind subdued wage growth during 2009–15 (Section 3.2).

That spare capacity has now largely been absorbed and the MPC judges that very limited slack remains (Section 5). Relative to expectations at the time of the May Report, there has been little news in labour market quantities. The participation rate and employment rate were slightly higher, and average hours slightly lower, than expected. The unemployment rate was 4.2% in the three months to May (Chart 3.1). This was broadly in line with the MPC’s judgement of the equilibrium rate of unemployment of 4¼%1, suggesting little scope for unemployment to fall further without generating excess wage pressure.

Broader measures also suggest that there is limited spare capacity in the labour market. In aggregate, the total net additional hours that people report wanting to work, over and above the hours they usually work each week, has fallen to around zero. As discussed in previous Reports, the proportion of the population who report that they would like a job but are not currently seeking one — the marginal attachment ratio — has fallen sharply in recent years (Table 3.A), suggesting that there is no significant spare capacity among those not actively looking for a job. The number of vacancies per person in the labour force — which is an indicator of the difficulty with which employers would be able to fill jobs — is above its pre-crisis average. The rate at which those already in employment are switching to new jobs has risen to close to pre-crisis rates, although it softened in Q1 (Chart 3.2). And survey measures of firms’ recruitment difficulties are at or above pre-crisis levels.

With little slack in the labour market, growth in the size of the workforce will come mainly from population growth. The MPC’s forecasts assume that the population evolves in line with the ONS’s latest principal population projection, published in October 2017. A key influence on population growth is net migration to the UK. In the year to December 2017, net inward migration rose to 282,000, slightly above the ONS projection. Within this, net migration from the EU has slowed since 2016 H1. The ONS projects net inward migration to fall somewhat in coming years (Chart 3.3), reducing population growth slightly.

The labour market is expected to tighten further in the near term. Employment has continued to grow solidly (Table 3.A) and labour demand growth appears robust. The strength of employment growth over the past few years has been associated with lower flows out of employment rather than higher flows into it (Chart 3.2). Within this, the redundancy rate is around half its pre-crisis average. Many survey indicators of employment intentions remain above their past averages and the number of vacancies remains high. As a result, the unemployment rate is projected to fall to 4.0% in 2018 Q3 (Chart 3.1), broadly as anticipated at the time of the May Report (Table 3.B).

Chart 3.1

The unemployment rate is projected to fall to 4.0% in Q3
Unemployment rate and Bank staff’s near-term projection

Chart 3.1

  • Sources: ONS and Bank calculations.

    (a) The beige diamonds show Bank staff’s central projections for the headline unemployment rate for the three months to March, April, May and June 2018 at the time of the May Report. The red diamonds show the current staff projections for the headline unemployment rate for the three months to June, July, August and September 2018. The bands on either side of the diamonds show uncertainty around those projections based on one root mean squared error of past Bank staff projections for the three-month headline unemployment rate.

Table 3.A

Labour demand growth remains robust
Selected measures of labour demand and labour market tightness

Table 3.A

  • Sources: Bank of England, BCC, CBI, CBI/PwC, KPMG/REC/IHS Markit, ONS and Bank calculations.

    (a) Changes relative to the previous quarter. Figure for 2018 Q2 is Bank staff’s projection, based on data to May.
    (b) Other comprises unpaid family workers and those on government-supported training and employment programmes classified as being in employment.
    (c) Measures for the Bank’s Agents (split by manufacturing and services for employment intentions), the BCC (non-services and services) and CBI (manufacturing, financial services and business/consumer/professional services; employment intentions also include distributive trades) are weighted together using employee job shares from Workforce Jobs. BCC data are not seasonally adjusted. Agents data are last available observation for each quarter.
    (d) The scores are on a scale of -5 to +5, with positive scores indicating stronger employment intentions over the next six months relative to the previous three months.
    (e) Net percentage balance of companies expecting their workforce to increase over the next three months.
    (f) Quarterly average. Recruitment agencies’ reports on the demand for staff placements compared with the previous month. A reading above 50 indicates an increase on the previous month and below 50 indicates a decrease.
    (g) Vacancies as a percentage of the workforce, calculated using rolling three-month measures. Excludes vacancies in agriculture, forestry and fishing. Figure for 2018 Q2 shows vacancies in the three months to June relative to the size of the labour force in the three months to May. Vacancies data start in 2001 Q2.
    (h) Redundancies as a percentage of total LFS employees, calculated using rolling three-month measures. Figure for 2018 Q2 is for the three months to May.
    (i) Number of those aged 16–64 who say they are not actively looking for work but would like a job, as a percentage of the 16–64 population. Figure for 2018 Q2 is for the three months to May.
    (j) The scores are on a scale of -5 to +5, with positive scores indicating greater recruitment difficulties in the most recent three months relative to normal.
    (k) Percentage of respondents reporting recruitment difficulties over the past three months.
    (l) Net percentage of respondents expecting skilled or other labour to limit output/business over the next three months (in the manufacturing sector) or over the next twelve months (in the financial services and business/consumer/professional services sectors).

Chart 3.2

Outflows from employment have been low relative to the past
Flows into and out of employment, and job-to-job flows

Chart 3.2

  • Sources: ONS and Bank calculations.

    (a) Dashed lines are averages from 2002 to 2007. Proportions of people in employment aged 16–69. Seasonally adjusted by Bank staff.
    (b) Proportion of people who reported having moved to or from employment in the past three months. Two-quarter moving averages.
    (c) Proportion of people who reported being in a job three months ago and report being in a job for less than three months.

Chart 3.3

Net migration is projected to fall from current levels
Decomposition of net inward migration by nationality

Chart 3.3

  • (a) Rolling four-quarter flows. Data are half-yearly to December 2009 and quarterly thereafter, unless otherwise stated. Figures by nationality do not sum to the total prior to 2012.
    (b) Data are half-yearly to December 2011 and quarterly thereafter.
    (c) Adjusted to include the ONS’s illustrative revised trend for the inward migration of non-EU students which accounts for an unusual pattern in the International Passenger Survey. That adjustment is represented by the faded non-EU bars.

Table 3.B

Monitoring the MPC’s key judgements

Table 3.B

3.2 Developments in pay growth

A tightening labour market and lower unemployment is typically associated with higher pay growth (Chart 3.4) as it becomes more difficult for firms to recruit and retain staff. Whole-economy regular average weekly earnings (AWE) growth — which excludes bonuses — rose to 2.7% in the three months to May from 2.0% a year earlier, broadly as anticipated.

Wage growth remains subdued relative to its past average, though much of that weakness is likely to reflect lower productivity growth than in the past. Labour productivity — the amount of output produced per worker — is a significant influence on the amount of revenue that companies generate, and therefore what they can afford to pay their employees. Therefore, while wage and productivity growth can deviate in the short run, they have tended to move together over time. Productivity fell during the financial crisis and its growth has remained subdued since then (Chart 3.5), particularly relative to its pre-crisis trend. Four-quarter growth in output per head is expected to have remained weak in 2018 Q2. Average hours worked tend to be volatile from one quarter to another, which in turn increases the volatility in output per hour relative to output per head. Indeed, a sharp fall in average hours worked since 2017 H1 has led to a divergence between these two measures of productivity growth.

Because productivity growth tends eventually to be fully reflected in wage growth, slower productivity growth can probably account for around half of the shortfall in average wage growth since 2010, relative to its pre-crisis average (Chart 3.6). Productivity growth is projected to pick up a little, reaching around 1¼% by 2019 — which will support some rise in wage growth — but it is expected to remain below its past average rate (Section 5).

The remaining weakness in wage growth is likely to be mainly due to labour market slack. During much of 2008–17, the unemployment rate was higher than the MPC’s judgement of the equilibrium rate of unemployment. While labour market slack has now largely been absorbed, it can take time for that to be fully reflected in wage growth.

Data from the Annual Survey of Hours and Earnings suggest that pay rises for those switching jobs had increased to pre-crisis rates, both for those moving to a new employer and for those moving to a new role with the same employer (Chart 3.7). Pay rises for those staying in the same job had remained subdued, however, and would need to increase to support a broader rise in labour cost pressures. These data are only available with a lag and the most recent relate to April 2017. Since then, AWE growth has risen and so could suggest that pay rises have broadened out. Recent evidence from the Bank’s Agents suggests that recruitment and retention pressures have pushed up pay growth over the past year (see Box 5). Contacts that reported recruitment and retention having become harder over the past 12 months had increased average pay growth by more than those who reported the level of difficulty as unchanged.

Chart 3.4

Wage growth has remained subdued as the unemployment rate has fallen
Wage Phillips curve: wage growth and unemployment

Chart 3.4

  • (a) Whole-economy AWE total pay excluding bonuses and arrears of pay. Percentage change on a year earlier.
    (b) Diamond for 2018 Q2 shows Bank staff’s projections, based on data to May.

Chart 3.5

Growth in output per head has remained subdued
Measures of labour productivity

Chart 3.5

  • Sources: ONS and Bank calculations.

    (a) Output is based on the backcast for the final estimate of GDP. Diamonds show Bank staff’s projections for 2018 Q2, based on data to May.

Chart 3.6

Subdued wage growth is partly due to weaker productivity growth
The unemployment gap and stylised decomposition of average wage growth

Chart 3.6

  • Sources: ONS and Bank calculations.

    (a) Faded bars/diamonds are projections. The stylised wage decomposition assumes a one-for-one relationship between productivity growth and wage growth over these periods.
    (b) Annual whole-economy total AWE growth.
    (c) Difference between wage growth and productivity growth.
    (d) Whole-economy productivity growth per head, based on the backcast of the final estimate of GDP.
    (e) Difference between the unemployment rate and Bank staff’s estimate of the medium-term equilibrium unemployment rate.
    (f) Data for 2018 Q2 are Bank staff’s projections, based on data to May.

Chart 3.7

Pay growth has recovered by more for those switching jobs
Median annual growth rates of pay

Chart 3.7

  • Sources: Annual Survey of Hours and Earnings and Bank calculations.

    (a) Pay growth is median annual growth rate in April. Based on hourly gross earnings obtained by dividing gross pay in the reference week by total hours worked. Workers moving jobs are defined as workers in employment in consecutive years in a different job. Workers moving employers are defined as workers in employment in consecutive years with a different employer.

3.3 The outlook for pay and labour costs

Annual growth in average wages excluding bonuses of 2.7% in the three months to May 2018 was higher than in 2016, when growth was around 2½%, and higher still than the average of around 1¾% a year during 2010–15. It is projected to remain around 2¾% in the second half of the year, broadly unchanged since the May Report.

Private sector regular pay growth has also strengthened, to a little under 3% in recent months. Other indicators of private sector pay pressures have also risen. Private sector settlements data are consistent with an increase in median pay growth of around 0.5 percentage points relative to a year ago. The Bank’s Agents’ measure of average growth in labour costs has picked up in recent quarters (Chart 3.8). The REC pay survey, which is a measure of the pay growth of new recruits, also implies a strengthening in pay growth.

In the public sector, AWE growth has picked up notably over the past year, although it softened slightly in the three months to May. Excluding bonuses, public sector pay growth has risen from around 1½% to 2¼% — having been somewhat more subdued than private sector pay growth since 2014 (Chart 3.9).

The 1% cap on public sector pay awards has been lifted from the 2018/19 pay round, which should contribute further to public sector pay growth. The MPC’s forecasts are conditioned on Office for Budget Responsibility (OBR) projections for public sector pay growth, which allow for the lifting of the 1% pay cap2. Since the OBR forecast was published, a number of public sector pay agreements for 2018/19 have been announced, as well as a multi-year agreement for the NHS, which could boost public sector pay slightly further. Following the next Budget in the autumn, the MPC’s forecast will incorporate updated OBR projections that include an estimate of the effects of these announcements.

Public sector pay rises will have a direct effect on whole-economy pay growth, as public sector employment constitutes around one sixth of overall employment. There may also be indirect effects, in part as some private sector companies use public sector settlements as a benchmark when negotiating pay agreements, and in part as private sector companies may have to offer higher salaries in response to recruit and retain staff. Empirically, while there is some evidence for a short-term influence of public sector settlements on those in the private sector, there is little empirical evidence for a significant long-term influence.3

Over the next few years, whole-economy pay growth is projected to rise to around 3½% as productivity growth rises slightly and the tightness of the labour market puts upward pressure on wage growth (Section 5).

For inflationary pressures, growth in unit labour costs is more relevant than wage growth alone. This depends on how fast wages and other costs of labour are rising relative to productivity. As explained above, part of the weakness in wage growth in recent years has been driven by weak productivity growth, and as such, unit labour cost (ULC) growth has been less subdued (Chart 3.10).

Non-wage labour costs, such as pension contributions, also affect labour cost growth. These costs boosted ULC growth in 2016–17, in part due to the phased introduction of auto‑enrolment of employees into pension schemes and the abolition of contracting out of the state pension. The minimum employer contribution to pension schemes under auto-enrolment rose in April, and is set to rise further over the next year, contributing a little to overall ULC growth.

Rising wage growth means that ULC growth is projected to average around 2¼% in coming years, a continuation of the gradual acceleration since the crisis. ULC growth averaged ½% during 2010–15 and 1¾% in 2016. Recently, ULC growth has picked up further, although it has been boosted by temporarily weak growth in output per head (Chart 3.10). In part that reflected a temporary dip in output growth in Q1 (Section 2) that was not mirrored in employment growth. As this effect diminishes, ULC growth declines a little from current rates, but remains higher than its average over the past few years, contributing to domestic cost and inflationary pressures (Section 4).

Chart 3.8

Indicators of pay growth have firmed over the past year
Private sector regular pay and survey indicators of pay growth

Chart 3.8

  • Sources: Bank of England, CBI, Chartered Institute of Personnel and Development (CIPD),
    KPMG/REC/IHS Markit, ONS and Bank calculations.

    (a) Private sector AWE total pay excluding bonuses and arrears of pay. Diamond for 2018 Q2 shows Bank staff’s projection, based on data to May.
    (b) Scaled to match the mean and variance of private sector regular pay growth since 2008 Q2.
    (c) Produced by weighting together survey indices for the pay of permanent and temporary new placements using employee job shares; quarterly averages.
    (d) Measures of expected pay for the year ahead. Produced by weighting together responses for manufacturing, distributive trades, business/consumer/professional services and financial services using employee job shares. Data for financial services are only available since 2009 Q1, and other sectors since 2008 Q2.
    (e) Pay increase intentions excluding bonuses over the coming year. Data only available since 2012 and are to 2018 Q1.
    (f) Quarterly averages for manufacturing and services weighted together using employee job shares. The scores refer to companies’ labour costs over the past three months compared with the same period a year earlier.

Chart 3.9

Wage growth has picked up in the private and public sectors over the past year

Regular pay by sector

Chart 3.9

  • (a) AWE total pay excluding bonuses and arrears of pay.

Chart 3.10

Unit labour cost growth has been temporarily boosted by weak productivity growth

Decomposition of four-quarter whole-economy unit labour cost growth

Chart 3.10

  • Sources: ONS and Bank calculations.

    (a) Whole-economy labour costs divided by real GDP, based on the backcast of the final estimate of GDP. The diamond shows Bank staff’s projection for 2018 Q2.
    (b) Self-employment income is calculated from mixed income, assuming that the share of employment income in that is the same as the share of employee compensation in nominal GDP less mixed income.

Box 5: Agents' update on business conditions

The Bank of England’s Agents have a long-standing role in providing economic intelligence to the Bank’s policymaking committees from their regular meetings with businesses. Some of the key information from Agents’ contacts considered by the Monetary Policy Committee at its August meeting is highlighted in this box. This replaces the Agents’ summary of business conditions, previously released a week after the Inflation Report, which will no longer be published.(1) A comprehensive quarterly report from the Agents on business conditions will be published alongside the MPC decision in non-Inflation Report months.

According to the Bank’s Agents, annual consumer spending growth rose slightly, boosted by the warmer weather and the football World Cup.(2) The underlying picture remained one of modest growth. Retailers reported subdued demand growth, especially for white goods and homewares, due to weak real income growth and housing market activity.

There was solid growth in business services activity, particularly relating to mergers and acquisitions, company voluntary agreements and Brexit advice.

Growth in domestic manufacturing output eased slightly but remained above its long-run average. Companies in supply chains for consumer goods faced headwinds from weaker demand growth, especially for cars and other big-ticket items, but demand for manufactured components from the oil and gas sector improved. Growth in manufacturing export volumes also eased slightly, but remained above average, and global demand was firm for aerospace, capital equipment and construction materials.

Construction output growth edged up, but remained sluggish. There was some catch-up following weather-related delays in 2018 Q1. However, the recent hot weather also caused challenges, for example through health and safety requirements or difficulties working with some materials. Many contacts faced capacity constraints.

Investment intentions for the next 12 months continued to be depressed by economic and political uncertainty. Contacts’ references to uncertainty had picked up, with many related to concerns around Brexit. UK-based subsidiaries of foreign-owned companies reported holding back investment, and firms with export markets or with international supply chains were reluctant to expand capacity until there was more clarity on future EU market access.

Recruitment difficulties had intensified. Average pay settlements were a little higher than a year ago, in a range of 2½%–3½%. Growth in total labour costs picked up slightly, partly as a result of the increase in employers’ pension auto-enrolment contributions. Increases in non-discretionary labour costs were reducing the scope for across-the-board pay rises for some companies.

Agents’ survey on the labour market

In June and July, the Agents surveyed business contacts about difficulties in recruiting and retaining staff.(3) They asked companies what actions they were taking to address these issues, including if there was any impact on pay growth in 2018.

The results suggest that companies found it more difficult to recruit and retain staff than last year, with around two thirds of respondents saying it had become harder to recruit and retain staff with key skills and around 40% reporting increased difficulties relating to staff for any positions (Chart A).

In response to rising recruitment and retention pressures, the most frequent action taken was to increase pay (Chart B). A greater proportion of firms increased pay for key existing staff than for new recruits or existing staff more generally. Contacts also reported increasing spending on recruitment, keeping vacancies open for longer and increasing investment in automation.

Contacts who had found recruitment and retention harder than a year ago had increased pay by more than those who reported the level of difficulty as unchanged, and had raised pay growth, compared with 2017, by more on average (Chart C). This was true of pay for both key skill positions and more broadly.

  • (1) The Agents’ scores will continue to be published on the Bank of England website.
    (2) This section covers intelligence gathered between early June and mid-July. References to activity generally relate to the past three months compared with a year earlier.
    (3) The survey was conducted between 4 June and 11 July. Responses were received from 370 companies, employing around 470,000 people.

Chart A

Recruitment and retention difficulties have increased on balance

Change in recruitment and retention difficulties compared to a year ago

Chart A

  • (a) The net percentage balance is the difference between the weighted balance of companies reporting that recruitment and retention had become harder or easier than a year ago. Half weight was given to those that responded ‘slightly harder’ or ‘slightly easier’, and full weight was given to those that responded ‘much harder’ or ‘much easier’.

Chart B

Recruitment and retention difficulties have pushed up pay

Changes made as a result of recruitment and retention difficulties

Chart B

  • (a) Companies were asked ‘Have you made any changes as a result of recruitment and retention challenges?’ Contacts were then asked to select which factors they had changed as a result of those challenges.

Chart C

Firms with greater recruitment and retention difficulties have raised pay growth by more than those that reported no change

Annual pay growth for given changes in recruitment and retention difficulties

Chart C

  • (a) Companies were asked for the change in their average wage bill per head in 2018 compared to 2017, and in 2017 compared to 2016.
This page was last updated 09 October 2018
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