Title: UK Economic Slack vs. Wage Growth: Implications for BoE Policy
Author: Adapted from insight originally published by EFX Data
In recent months, there has been a growing divergence between traditional economic measures indicating slack in the UK economy and data suggesting continued strength in wage growth and inflationary pressures. This dynamic has sparked debate among economists and market participants about the appropriate policy path for the Bank of England (BoE), particularly in regard to the timing and extent of any potential rate cuts.
Although indicators such as declining job vacancies and broader signs of weakening economic activity reinforce the idea that monetary policy is exerting its intended restrictive influence, the persistence of strong wage growth and stubborn services inflation point to risks that inflation could remain entrenched above target. In this article, we analyze some of the key economic indicators that contribute to the current policy conundrum and assess what they may mean for future BoE rate decisions.
1. Labor Market Slack: Is Monetary Policy Working?
The term “economic slack” refers to the degree of underutilization in the economy, particularly within the labor market. When slack is high, it typically results in softer wage pressures and lower inflation expectations. Recent UK indicators have pointed toward a loosening labor market, which might suggest that the BoE’s aggressive policy tightening—raising its benchmark policy rate to 5.25 percent—has been effective.
Key labor market developments include:
– Declining job vacancies: Job openings across the UK have steadily decreased during the past several months, falling from record highs seen during the post-COVID recovery period. Lower vacancies tend to imply declining labor demand which, in theory, should alleviate pressure on wages.
– Rising unemployment claims: Claimant count data indicates a modest uptick in the number of individuals filing for unemployment-related benefits. Although still below historical averages, the upward trajectory could be interpreted as a sign that businesses are beginning to slow hiring or trim payrolls.
– Survey-based employment expectations: Business surveys, including the Purchasing Managers’ Index (PMI) and the Confederation of British Industry (CBI) employment intentions reports, suggest that firms have become more cautious when it comes to expanding headcount. This adds another layer of evidence supporting the idea of economic cooling.
Despite these signs of moderation, the labor market remains relatively tight in the context of historical standards. The unemployment rate remains low by long-term norms, and workforce participation—though slightly below pre-pandemic levels—has started to stabilize. This suggests a complex picture where slack is emerging, but only gradually.
2. Wage Dynamics Remain Robust
One puzzle that continues to baffle central bankers and analysts alike is why wages remain so resilient in the face of a cooling job market. Nominal wage growth, particularly within regular pay excluding bonuses, has continued to rise at rates well above the BoE’s 2 percent inflation target.
According to recent data from the UK’s Office for National Statistics (ONS):
– Annual growth in regular pay stood at 6 percent in the latest readings, only slightly below the multi-decade highs seen in mid-2023.
– Wages in services sectors such as health, education, and professional services remain particularly strong, driven in part by labor shortages and increased demands for higher pay amid elevated living costs.
– Public sector pay agreements have contributed to some of the ongoing wage pressure, with several negotiated settlements pushing pay rates higher than private sector averages.
The persistence of wage growth at these levels is significant because of its potential to feed into future inflation. A basic inflation mechanism operates as follows: if workers receive higher wages, they may spend more, boosting demand for goods and services. Simultaneously, businesses facing rising labor costs may pass those costs on to consumers via higher prices. This so-called wage-price spiral is something the BoE remains acutely aware of.
3. Services Inflation Not Budging
Another key concern for policymakers is the behavior of services inflation, which has proven particularly sticky. Unlike goods inflation, which has moderated
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