Bank of England Forward Guidance ignores the falls in UK real wages

Yesterday evening Michael Saunders of the Bank of England spoke in Southampton and gave us his view on our subject of today the labour market.

 the output gap is probably closed……….. The labour
market continued to tighten, and the MPC judged in late 2018 that the output gap had closed, with supply
and demand in the economy broadly in balance.

As you can see we quickly go from it being “probably closed” to “had closed” and there is something else off beam. You see if there is anyone on the Monetary Policy Committee who would think it is closed is Michael via his past pronouncements, so if he is not sure, who is? This leads us straight into the labour market.

In general, labour market data suggest
the output gap has closed. For example, the jobless rate is slightly below the MPC’s estimate of equilibrium,
vacancies are around a record high, while pay growth has risen to around a target-consistent pace (allowing
for productivity trends).

Poor old Michael does not seem to realise that if pay growth is consistent with the inflation target he does not have a problem. Of course that is before we hit the issue of the “equilibrium” jobless rate where the Bank of England has been singing along to Kylie Minogue.

I’m spinning around
Move outta my way
I know you’re feeling me
‘Cause you like it like this

In terms of numbers the original Forward Guidance highlighted an unemployment rate of 7% which very quickly became an equilibrium one of 6.5% and I also recall 5.5% and 4.5% as well as the present 4.25%. Meanwhile the actual unemployment rate is 3.8%! What has actually happened is that they have been chasing the actual unemployment rate lower and have only escaped more general derision because most people do not understand the issue here. Let’s be generous and ignore the original 7% and say they have cut the equilibrium rate from 6.5% to 4.25%. What that tells me is that the concept tells us nothing because on the original plan annual wage growth should be between 5% and 6%.

What we see is that an example of Ivory Tower thinking that reality has a problem and that the theory is sound.  It then leads to this.

This would reinforce the prospect that the
economy moves into significant excess demand over the next 2-3 years, and hence that some further
monetary tightening is likely to be needed to keep inflation in line with the 2% target over time.

Somebody needs to tell the Reserve Bank of India about this excess demand as it has cut interest-rates three times this year and also Australia which cut only last week. Plus Mario Draghi of the ECB who said no twice before the journalist asking him if he would raise interest-rates last week finished his question and then added a third for good measure.

Wage Data

We gain an initial perspective from this. From this morning’s labour market release.

Including bonuses, average weekly earnings for employees in Great Britain were estimated to have increased by 3.1%, before adjusting for inflation, and by 1.2%, after adjusting for inflation, compared with a year earlier.

If we start with the economic situation these numbers are welcome and let me explain why. The previous three months had seen total weekly wages go £530 in January, but then £529 in both February and March. So the £3 rise to £532 in April is a welcome return to monthly and indeed quarterly growth. As to the number for real wages it is welcome that we have some real wage growth but sadly the official measure used called CPIH is a poor one via its use of imputed rents which are never paid.

Ivory Tower Troubles

However as we peruse the data we see what Taylor Swift would call “trouble, trouble trouble” for the rhetoric of Michael Saunders. Let us look at his words.

Wage income again is likely to do better than expected.

That has been something of a hardy perennial for the Bank of England in the Forward Guidance era where we have seen wage growth optimism for just under 6 years now. But whilst finally we have arrived in if not sunlit uplands we at least have some real wage growth there is a catch. Let me show you what it is with the latest four numbers for the three monthly total wages average. It has gone 3.5% in January then 3.5%, 3.3% and now 3.1%. Also if we drill into the detail of the April numbers I see that the monthly rise was driven by an £8 rise in weekly public-sector wages to £542 which looks vulnerable to me. Was there a sector which got a big rise?

Thus as you can see on the evidence so far we have slowing wage growth rather than it picking up. That would be consistent with the slowing GDP growth yesterday. So we seem to be requiring something of a “growth fairy” that perhaps only Michael is seeing right now. This is what he thinks it will do to wage growth.

Pay growth has recently
risen to about 3% YoY and the May IR projects a further modest pickup (to about 3.5% in 2020 and 3.75% in 2021). That looks reasonable in my view: if anything, with the high levels of recruitment difficulties, risks may
lie slightly to the upside.

Real Wages

There is a deeper problem here as whilst the recent history has been better the credit crunch era has been a really poor one for UK real ages. Our official statisticians put it like this.

£468 per week in real terms (constant 2015 prices), higher than the estimate for a year earlier (£459 per week), but £5 lower than the pre-recession peak of £473 per week for April 2008.

As you can see even using their favoured ( aka lower) inflation measure real wages are in the red zone still. I noted that they have only given us the regular pay data so I checked the total wages series. There we have seen a fall from the £512 of January 2008 to £496 in April so £16 lower and just in case anyone looks it up I am ignoring the £525 of February 2008 which looks like the equivalent of what musicians call a bum note.

We see therefore that the closed output gap measured via the labour market has left us over a decade later with lower real wages!

Comment

If we view the UK labour market via the lenses of a pair of Bank of England spectacles then there is only one response to the data today.

Between February to April 2018 and February to April 2019: hours worked in the UK increased by 2.4% (to reach 1.05 billion hours) the number of people in employment in the UK increased by 1.1% (to reach 32.75 million).

From already strong numbers we see more growth and this has fed directly into the number they set as a Forward Guidance benchmark.

For February to April 2019, an estimated 1.30 million people were unemployed, 112,000 fewer than a year earlier and 857,000 fewer than five years earlier.

It is hard not to have a wry smile at falls in unemployment like that leading to in net terms the grand sum of one 0.25% Bank Rate rise. Also even a pair of Bank of England spectacles may spot that a 2.4% increase in hours worked suggests labour productivity is falling.

But the Forward Guidance virus is apparently catching as even the absent-minded professor has remembered to join in.

BoE’s Broadbent: If Economy Grows As BoE Forecasts, Interest Rates Will Probably Need To Rise A Bit Faster Than Market Curve Priced In May ( @LiveSquawk )

My conclusion is that we should welcome the better phase for the UK labour market and keep our fingers crossed for more in what look choppy waters. Part of the problem at the Bank of England seems to be that they think it is all about them.

Second, why should growth pick up without any easing in monetary or fiscal policies? ( Michael Saunders)

Of course that may be even more revealing…..