Recession forecasts for the UK collide with stronger wage growth

As we arrive at UK labour market day the mood music around the UK economy has shifted downwards. For example the Resolution Foundation has chosen this week to publish this.

Technical recessions (where economic output contracts for two consecutive quarters) have come along roughly once a decade in the UK. With the current period of economic
expansion now into its tenth year, there is therefore concern that we are nearer to the next recession than we are to the last.

At this point we do not learn a great deal as since policy has been to avoid a recession at almost nay cost for the last decade then the surprise would be if we were not nearer to the next recession.Also they seem to be clouding the view of what a technical recession ( where the economy contracts only marginally) is with a recession where it contracts by more. But then we get the main point.

Indeed, a simple model based on financial-market data
suggests that the risk of a recession is currently close to levels only seen around the time of past recessions and sharp slowdowns in GDP growth, and is at its highest level since 2007.

Okay so what is it?

One indicator that is often cited as a predictor of future recessions is the difference between longer-term and shorter-term yields on government bonds, often referred to as the ‘slope’ of the yield curve……..If shorter-term rates are above longer-term ones (negative slope), it suggests markets are expecting looser monetary policy in future than today, implying expectations of a deterioration in the outlook for the economy.

Okay and then we get the punchline.

It shows that this indicator has increased significantly in the run up to the previous three recessions. And it has risen from close to zero in 2014 to levels only seen around recessions and sharp slowdowns in GDP growth by 2019 Q2, reflecting the flattening of the yield curve……..

Thoughts

The problem with this type of analysis is that it ignores all the ch-ch-changes that have taken place in the credit crunch era. For example because of all the extraordinary monetary policy including £435 billion of purchases of UK government bonds by the Bank of England there is very little yield anywhere thus the yield curve will be flatter. That is a very different situation to market participants buying and selling and making the yield curve flatter. The danger here is that we record a false signal or more formally this is a version of Goodhart’s Law.

Also frankly saying this is not much use.

Our simple model suggests, therefore, that there is an elevated chance of the UK facing a recession at some point in the next three years.

 

UK Labour Market

The figures themselves provoked a wry smile because the downbeat background in terms of analysis collided with this.

Estimated annual growth in average weekly earnings for employees in Great Britain increased to 3.4% for total pay (including bonuses) and 3.6% for regular pay (excluding bonuses)……..Annual growth in both total pay (including bonuses) and regular pay (excluding bonuses) accelerated by 0.2% in March to May when compared with February to April.

The rise for the latter was the best in the credit crunch era and provoked some humour from Reuters. At least I think it was humour.

The pick-up in pay has been noted by the Bank of England which says it might need to raise interest rates in response, assuming Britain can avoid a no-deal Brexit.

The good news section of the report continued with these.

The UK unemployment rate was estimated at 3.8%; it has not been lower since October to December 1974. The UK economic inactivity rate was estimated at 20.9%, lower than a year earlier (21.0%).

So higher wage growth and low unemployment.

Nuance

Actually as the two factors above are lagging indicators you could use them as a recession signal. But moving to nuance we found that in the employment data. This has just powered away over the past 7 years but found a bit of a hiccup today.

The UK employment rate was estimated at 76.0%, higher than a year earlier (75.6%); on the quarter, the rate was 0.1 percentage points lower, the first quarterly decrease since June to August 2018.

At this stage in the cycle with the employment rate so high it is hard to read especially when we notice these other measures.

Between March to May 2018 and March to May 2019: hours worked in the UK increased by 1.9% (to reach 1.05 billion hours)…….the number of people in employment in the UK increased by 1.1% (to reach 32.75 million)

We gain a little more insight from looking at just the month of May which was strong in this area.

The single month estimate of the employment rate, for people aged 16 to 64 years in the UK, for May 2019 was 76.2%

But not as strong as April which was at 76.4%! Oh and in case you are wondering how the three-month average got to 76% it was because March was 75.5%. You could press the Brexit Klaxon there but no-one seems to be doing so, perhaps they have not spotted it yet. Anyway barring a plunge in June the employment rate should be back.

Wages

We can fig deeper into these as well as we note something we have been waiting for.

the introduction of the new National Living Wage rate (4.9% higher than the 2018 rate) and National Minimum Wage rates which will impact the lowest-paid workers in sectors such as wholesaling, retailing, hotels and restaurants.

When we note who that went to we should particularly welcome it although it is different to wages being higher due to a strong economy as it was imposed on the market. There was also this.

pay increases for some NHS staff which will impact public sector pay growth

That provokes a few thoughts so let me give you some number crunching. Public-sector pay is at £542 per week higher than private-sector pay ( £534) and is growing slightly more quickly at 3.6% versus 3.4%. However if we look back to the year 2000 we see that pay growth has been remarkably similar at around 72%. Actually in the categories measured the variation is very small with manufacturing slowest at 69.3% and construction fastest at 74.8%.

If we look at the case of real wages we get a different picture.

In real terms (after adjusting for inflation), total pay is estimated to have increased by 1.4% compared with a year earlier, and regular pay is estimated to have increased by 1.7%.

It starts well although even here it is time for my regular reminder that the numbers rely on the official inflation series and are weaker if we use the Retail Price Index or RPI. But even so the credit crunch era background remains grim.

For May 2019, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at:

£503 per week in nominal terms

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£460 per week), but £5 (1.0%) lower than the pre-recession peak of £473 per week for April 2008

 

The equivalent figures for total pay are £498 per week in May 2019 and £525 in February 2008, a 5.0% difference.

Again that relies on a flattering inflation measure. But the grim truth is that real wages are in a depression and have been so for a bit more than a decade.

Comment

So there you have it in spite of the fears around this sector of the UK economy continues to perform strongly and give quite a different measure to say economic output or GDP. Also as we note the increase in hours worked and that GDP growth is fading we are seeing a wage growth pick-up with weak and probably negative productivity growth. We will have to see how that plays out but let me show you something else tucked away in the detail and let us go back to the Resolution Foundation.

Real pay growth grew by more than 3.5% for the real estate sector but fell by more than 1.0% in the arts and entertainment sector.

A bit harsh on luvvies who have been one of the strongest sectors in the economy. But I have spotted something else which may be a factor in why estate agents and the like are doing so well.

The proportion of UK mortgage lending at (LTV) ratios of 90% or higher was 18.7% of all mortgage lending in 2019 Q1. ( @NobleFrancis )

Odd that as I recall out political class singing along with Depeche Mode.

Never again
Is what you swore
The time before
Never again
Is what you swore
The time before

 

 

 

 

 

10 thoughts on “Recession forecasts for the UK collide with stronger wage growth

  1. We have just settled for 2.5% where I work, which was the RPI figure(for February I think).

    Gave up telling the youngsters they are falling behind every year, and some time in the near future they will see their bank statement says they are overdrawn, as opposed to now where they think they are well off earning a lot more than their friends, employers will reduce everyone’s pay close to the minimum wage or an amount that after tax doesn’t make much difference anyway, 40% threshold is now taking in record numbers of employees whereas once it used to only affect the rich(remember my description of communism – and my question to my brother when I was younger – “but who on earth would study and train to be a doctor/engineer/scientist if the wages were the same as a labourer?”) Well its happening now, builders earn MORE than engineers and doctors, I know of bricklayers earning £350 a day. Some could work seven days a week for as long as they want but most just do six, that’s £110,000 p.a to save you doing the maths. Also, being self employed means they pay less tax than most people earning half their wages.

    And yet the universities are full of kids who think that studying for six years(A levels included) and spending £30-40,000 is a good idea, to get a degree to get a job that pays £25,000 p.a f they’re lucky.

    As a PS, sterling in freefall again today, getting very close to the target of 0.9050 against the Euro I predicted earlier this year.

    • re: t he universities are full of kids who think that studying for six years(A levels included) and spending £30-40,000 is a good idea, to get a degree to get a job that pays £25,000 p.a f they’re lucky.

      1, it can be said to be their money and not the HMG – thus off balance debt
      2, keeps them off the dole/unemployment lines

      frankly I don’t think the jobs are there for them . If they are smart they will go abroad ( those with good degrees , you know, the ones we’d like to keep here) adopt citizen ships , like Canada, and not pay a penny back.

      the ones with wet paper bag degrees will be on benies for life with zero hour contracts , and still not pay a penny back …

      I think the whole damm thing is a scam , no party will change it though

      Forbin,

      PS: it also waters down those of us who had fewer exams to pass but had to work hard to get those. Hurrah! more kids have A levels , Bsc , etc , here just write yer name down and yer passed !! 😉

  2. Ikea was very busy on Saturday morning – the overflow car park was full with cars waiting for spaces to come available. No recession indicator there, then.

    • at IKEA prices ? wowzer , must be doing well then 😉

      Forbin

      PS: prob. bashing the credit card again…..

      PPS: any chance we’re going to get a credit card with -1.0% interest ( leave it alone and it’ll pay itself off ! – yay! )

  3. Great blog, Shaun, as usual.
    It is a good point you make about how the yield curve may no longer be a useful advance recession indicator because of QE. It is also valid for North America where a flattening of the yield curve has also been interpreted as a sign of an impending recession.
    I deflated the nominal wages myself using the data on the ONS database. In real terms, total pay increased in March-April-May over the previous year by 0.6% based on the RPI, 1.5% based on the CPI, 1.6% based on the CPIH (versus 1.4% for the official estimate) and 1.2% for the RPIJ. In real terms, regular pay increased in March-April-May over the previous year by 0.8% based on the RPI, 1.6% based on the CPI, 1.7% based on the CPIH and 1.4% for the RPIJ. There is rounding error in these estimated growth rates, which is likely why I did not match the official real total pay percentage increase using the CPIH as a deflator as I should have, but this should not change the rankings of the estimates for the different deflators. As you know, I prefer using the RPIJ as deflator. It is easy to see why the powers that be are so strong in their support of CPIH, despite its obvious failings. It gives the highest estimates of real wage growth for both total pay and regular pay.

    • Hi Andrew

      Thank you for the calculations for the different inflation indices. You are right about CPIH which was chosen exactly on the grounds you mention. It was the way they could try and claim they were allowing for owner-occupied housing with the least effect on the numbers. So real wage growth was always likely to be inflated using it

      In the short term the inflation numbers should tend to drift together. We will find out the latest house price numbers tomorrow but the overall trend has been lower which should be feeding in over time to the house price depreciation component of the RPI numbers.

  4. Public sector pay is much higher surely, as it doesn’t take pension worth circa 30% of salary into account? Private sector DC members generally get no more than legal 4% minimum from employers. Then include fewer working hours and more holiday entitlement, and the pay gap looks like a chasm!

    P.S. The High Court (I believe) ruled this week that the 2015 reduction in pension generosity for younger and new public sector workers has been deemed as age discrimination. Poorer private sector workers are about to face an extra £4bn per year bill to fund the comfortable retirement of government employees.

    • Hi PT

      Pensions will be separate to this as it is based on gross pay or what would be in your pay packet if such things still exist.Also many public-sector workers have to pay in a percentage of salary although of course much less than they would have to pay for the pension benefit on the free market.

      The whole pension system has become something of a shambles as the mess created by what the latest changes to the lifetime allowance and their impact on doctors have done to the NHS.

  5. With tax credits, a mandated minimum wage, and housing benefits we have experienced an infinite capacity to create low productivity work combined with seemingly limitless supplies of labour. A massive increase in the gangmaster economy goes some way to explain the fall in real wages and productivity. Hand car washes, fruit pickers abandoning farms in eastern europe to avail themselves of mandated minimum wages, tax credits and housing benefits plus all the other freebies from NHS to museums. The other explanation is the collapse of the credit bubble that falsely inflated financial services wages and productivity.

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