While employment growth has softened, the labour market remains tight.
Pay growth has risen to its highest rate since 2008.
Productivity growth has remained weak.
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).
The labour market remains tight
Selected measures of labour demand and labour market tightness
- Sources: Bank of England, British Chambers of Commerce (BCC), CBI, CBI/PwC, KPMG/REC/IHS Markit, ONS and Bank calculations.
a Changes relative to the previous quarter. Figure for 2019 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, 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 growth on the previous month and below 50 indicates a decrease.
g Proportion of people who reported being in a job three months ago who report being in a job for less than three months.
h 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.
i Percentage of respondents reporting recruitment difficulties over the past three months.
j 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 12 months (in the financial services and business/consumer/professional services sectors).
Some indicators suggest that companies are operating a little below normal capacity
Survey indicators of capacity utilisationa
- Sources: Bank of England, BCC, CBI, CBI/PwC, ONS and Bank calculations.
a Measures are produced by weighting together surveys from the Bank’s Agents, the BCC (non-services and services) and the CBI (manufacturing, financial services, business/consumer/professional services and distributive trades) using shares in nominal value added. The BCC data are not seasonally adjusted. The Agents’ data for 2019 Q2 are for May.
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.
The unemployment rate is expected to fall slightly to 3.7% in 2019 Q3
Unemployment rate and Bank staff’s near-term projectiona
- 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 2019 at the time of the May 2019 Report. The red diamonds show the current staff projections for the headline unemployment rate for the three months to June, July, August and September 2019. 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.
There are signs that demand for labour may have eased
Number of vacancies
Wage growth has picked up as the unemployment rate has fallen
Wage Phillips curve: wages and unemploymenta
- a Whole-economy AWE total pay excluding bonuses and arrears of pay. Percentage change on a year earlier. Diamond for 2019 Q2 shows Bank staff’s projections, based on data to May.
Survey indicators suggest pay growth is likely to stabilise
Indicators of pay growth
- Sources: Bank of England, CBI, Chartered Institute of Personnel and Development (CIPD), KPMG/REC/IHS Markit, ONS and Bank calculations.
a Three-month average growth on the same period a year earlier. Figures for 2019 Q2 are Bank staff’s projections, based on data to May.
b Total pay excluding bonuses and arrears of pay.
c 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 only available since 2009 Q1, and other sectors since 2008 Q2.
d The scores refer to companies’ labour costs over the past three months compared with the same period a year earlier. Scores of -5 and 5 represent rapidly falling and rapidly rising costs respectively, with zero representing no change. Services and manufacturing scores are weighted together using employee job shares from Workforce Jobs.
e Pay increase intentions excluding bonuses over the coming year. Data only available since 2012.
f Quarterly averages for the pay of permanent and temporary new placements weighted together using LFS employee job shares. A reading above 50 indicates growth on the previous month and below 50 indicates a decrease.
Monitoring the MPC’s key judgements
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
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’.
Potential supply growth is projected to remain subdued
Decomposition of estimated potential supply growtha
- a Average percentage point contributions to annual growth unless otherwise specified. Contributions may not sum to the total due to rounding.
b Positive numbers indicate that a fall in the equilibrium unemployment rate has increased potential labour supply.
c The decomposition is based on a growth-accounting framework using a constant returns to scale Cobb-Douglas production function, with total output to capital elasticity of ⅓. Total factor productivity is a residual.
d Capital deepening refers to growth in capital services per person-hour. Capital includes structures, machinery, vehicles, computers, purchased software, own-account software, mineral exploration, artistic originals and R&D. Calculations are based on Oulton, N and Wallis, G (2016), ‘Capital stocks and capital services: integrated and consistent estimates for the United Kingdom, 1950–2013’, Economic Modelling.
e Total factor productivity growth refers to improvements in the efficiency with which both capital and labour are used to produce output.
Box 4 Capital and labour growth
For much of the period since the financial crisis, investment growth has been weak, while employment growth has been relatively strong (Chart A). As a result, capital deepening — growth in the capital to labour ratio — has been subdued, and is well below its pre-crisis rate. That trend is apparent across the G7 economies (Chart B).
Companies might have been less incentivised to invest in capital if the returns on the investment are lower, such that it results in less additional output. That would be consistent with subdued growth in total factor productivity (TFP), which measures the efficiency with which capital and labour are used to produce output. TFP growth has been weak across advanced economies since the financial crisis, and that could in turn reflect slower global trade growth. Trade growth tends to be associated with productivity gains through greater economies of scale, increased competition and exposure to new ideas.
Companies might also have invested less if the cost of capital relative to labour has risen. Heightened global policy uncertainty since the crisis (Chart 1.3, Section 1) may have increased the required rate of return on new investments, incentivising firms to meet new demand with labour rather than with capital.1 Heightened uncertainty may have also encouraged some businesses to increase employment rather than capital because hiring is typically a more flexible way to increase capacity. Those global developments could have been exacerbated in the UK by increased Brexit uncertainties, although growth in the capital to labour ratio has risen a little since 2016.
In the UK, subdued growth in the capital to labour ratio compared with the pre-crisis period is largely accounted for by lower growth in capital relative to the number of people employed within sectors (dark blue bars in Chart C). Manufacturing accounts for a large part of that weakness, as investment has been weak and the past downward trend in employment has levelled off somewhat. The manufacturing sector is also likely to be particularly affected by slower global trade growth.
A small part of the slowdown also reflects a shift in the sectoral composition of the UK economy, away from industries that use a lot of capital towards those that are less capital-intensive (light blue bars in Chart C). That reflects a structural trend in which the services sector has grown more rapidly than the manufacturing sector in the UK, like in other advanced economies. Production in the services sector tends to be more labour-intensive than in manufacturing.
The capital to labour ratio is likely to continue to grow at a subdued pace in coming years. Around a third of respondents to the Agents’ labour market survey expected to use more capital than labour over the next 12 months (Box 2). But growth in the capital stock, and therefore the capital to labour ratio, is expected to remain lower than before the crisis, as Brexit-related uncertainties weigh on business investment and TFP growth remains weak.
1. For more information, see Broadbent, B (2019), ‘Investment and uncertainty: the value of waiting for news’.
Investment growth has been weak relative to employment growth since the crisis
Four-quarter growth in business investment and employmenta
- Sources: ONS and Bank calculations.
a Four-quarter moving average growth rate.
b Chained-volume measure. Data adjusted for the transfer of nuclear reactors from the public corporation sector to central government in 2005 Q2.
Growth in capital to labour ratios have been weak across the G7 economies
G7 capital to labour ratiosa
- Sources: ONS, Penn World Table 9.1 and Bank calculations.
a Annual estimates of capital to labour ratios calculated as capital services divided by employment in heads. For the G7 economies (excluding the UK), the estimates of capital services are from Penn World Table. For the calculation of the UK capital to labour ratio, see Chart C footnote a. UK measure is for the private sector.
Subdued growth in the UK capital to labour ratio has been largely accounted for by lower capital to labour growth within sectors
Contributions to four-quarter growth in the UK capital to labour ratioa
- Sources: ONS and Bank calculations.
a Total capital to labour ratio calculated as capital services divided by employment in heads. Contributions between sectors calculated using changes in each sector’s relative labour share. Contributions within sectors are residuals.