UK labour market and the BOE

By Kathleen Brooks

Wage growth in the UK slowed to 4% in the three months to July, the lowest rate of wage growth excluding bonuses since 2021. It also suggests that real wage growth, when adjusted for inflation , is now 1.8%, which is below the BOE’s 2% target rate for inflation. This would usually cause a wave of euphoria about extra rate cuts and the prospect of lower interest rates, however, not this month. We do not believe that the moderation in UK wage growth will shift the dial for the Bank of England for two reasons. Firstly, there could be more wage pressures to come, and secondly, the UK economy has strengthened more than expected so far this year, which could boost employment growth.

More wage increases in the pipeline

To explain our view in more detail, we would point to the Low Pay Commission’s recent proposal to increase the national living wage by 6% next year. In March the same commission suggested a 3.8% increase, so this is a significant upgrade. This increase still has to be approved by the government and put into law; however, the Labour government has pledged to raise the floor on wages. The Bank of England will need to weigh up the impact of a significant increase in the minimum wage on inflation pressures, along with fears from business that it could lead to rising unemployment before they make their next policy move.

The hawks are still a strong force at the BOE

It is worth noting that the BOE voted to cut interest rates last month by 5-4. Thus, there is still an important hawkish faction at the BOE who are resistant to rate cuts. This is why today’s moderation in wage growth may not have a big impact on the UK’s interest rates market. The market is still only pricing in 1 full rate cut for this year, although there is a decent chance of a second cut, with 46bps of cuts currently priced in between now and December. There are a further 89bps of rate cuts priced in for the first 8 months of next year, and this looks too rich for us at this stage. We think that the strength of the UK economy along with the prospect of sticky inflation down the line, due to an increase to public sector workers pay and the expected increase to the minimum wage, will mean that the BOE is more cautious than its central bank peers when it comes to rate cuts. We expect them to lay out this argument when they deliver their next Monetary Policy Report in November, the market also expects them to cut interest rates at the same meeting.

UK economic strength could boost the labour market

The second reason why today’s labour market report could give the BOE pause for thought on the extent of rate cuts is the strength of the economy and the pace of job creation. The UK economy is still creating jobs at a decent clip this year compared to last. In August, the number of pay rolled employees may have slipped on the month, however, the ONS estimates that 122,000 jobs were created between August 2023- August 2024. There is a question about the accuracy of the ONS labour force survey, so these changes should be treated with caution. However, there are a few reasons why we think that the ONS could be underestimating employment growth in the UK: although the economic inactivity rate for those of working age was 21.9%, this is higher than a year ago, but is down on the last quarter, so there is room for this number to improve. Added to this, the employee jobs rate has started to stabilize, after declining for most of the last 2 years. This could also be a sign that the UK’s economic growth spurt in 2024 is boosting employment levels.

Soft landing in the UK could put UK rate cuts on ice

Overall, this morning’s data suggests that the UK economy is enjoying a soft landing: decent jobs growth and moderating wage pressures. However, this also supports a cautious BOE that can take its time cutting interest rates and does not need to ‘panic cut’ to support the economy. This is supportive of the pound, which is still the top performing currency in the G10 FX space this year and is higher by more than 3% vs. the USD. GBP/USD has moved higher on the back of today’s labour market data and is back above $1.31. We think that the pound may continue to trade with an upside bias in the coming days, and we look for GBP/USD to get back towards $1.32.

The pound’s detrimental effect on UK stocks

The FTSE 100 and the FTSE 250 are bucking the trend for higher European stock markets on Tuesday, after US markets staged a stunning recovery rally on Monday. A strengthening pound can weigh on UK stocks, since the majority of revenues generated by the FTSE 100 are from overseas, and although the FTSE 250 is considered a more domestically focused index, it also generates approx. 55% of revenues from outside the UK. This means that a strengthening pound can weigh on profit levels.

Astra Zeneca weighs on the FTSE 100

Astra Zeneca is the biggest drag on the FTSE 100 so far on Tuesday. Its stock price has been weighed down after a lung cancer drug trial showed mixed results, which could make it difficult to get approval by the FDA in the US in the coming weeks. Unsurprisingly, the health care sector is weighing on the FTSE 100 this morning, however, consumer staples are also lower, while real estate and industrials are the top performing sectors. So far in September, M&A news has impacted the FTSE 100, and Rightmove is the top performing stock, while utilities are up nearly 5%, IAG is also a top performer along with British American Tobacco.

Why the FTSE 100 could follow the Dow Jones

The mix of companies that are dominating the FTSE 100 so far in September is a sign that the global equity market rally is broadening out, and also that investors are favouring the UK’s defensive credentials. This is why the FTSE 100 has been the most resilient of the major European indices so far in September, and is performing in line with the Dow Jones in the US. If the Dow continues its rally, this is good news for the FTSE 100.

Chart 1: 6-month chart of the FTSE 100, the Dow Jones and the Equal weighted S&P 500 index. As the US stock market rally broadens out, the FTSE 100 and the Dow Jones are tracking each other more closely. We expect this relationship to continue, as big tech struggles.

Source: XTB and Bloomberg