A survey conducted by Markit for the Recruitment and Employment Confederation has reported that rates of pay for permanent and temporary staff are experiencing a sharp rise driven by an ongoing decline in the number of job applicants.
Job vacancies in the UK increased to 774,000 in May this year from 770,000 in April. The metric averaged 603,050 from 2001 until 2017, reaching an all-time high of 777,000 in March of 2017 and a record low of 432,000 in May of 2009 as the aftermath of the financial crisis rippled out from financial services into the wider economy.
This coincides with the decline in UK unemployment which fell to 4.5% in the three months to May 2017, below the level of 4.6% recorded in the previous period. It is the lowest jobless rate since June 1975.
Source: Office for National Statistics
The labour markets
The chart above illustrates job vacancies and the unemployment rate in the UK over the past decade. The toppled wine glass shape has an inverse correlation with an R-Squared of 0.9465. That is as close to perfect between the two variables as one could hope to see. One must suspect that there is a degree of auto-correlation, however I want to convey a key point... That is that the labour market includes the supply of labour by households and the demand for labour by firms. Wages represent the price of labour, which provide an income to households and represent a cost to firms.
With the labour force participation rate in the UK unchanged at 78.50% in April, equal to the all-time high in the past four decades, wage pressure will start to materialise in the economy.
Naturally at higher wages many employers would look to make a shift in the factors of production away from labour to capital machinery, however, that is not always possible or appropriate. Outlays on capital stock can be extremely expensive and are be used over many years, whereas labour, even if “relatively expensive”, can be hired on short-term or even zero-hours contracts.
With a large lack of certainty over Westminster politics and the nature of Brexit arrangements that will be delivered in 2019, hiring more labour may prove to be the most viable and certainly most flexible option in the short to medium-term.
Therefore, it is not an exaggeration to suggest that the current UK labour demand is proving to be increasingly inelastic particularly when seeking employees that can deliver a higher level of marginal revenue product so the “Labour Demand 2” curve comes into effect seeing the wage rate rise from W1 to W2 as the quantity of labour that is demand rises to Q2 from Q1 even with an unchanged labour supply schedule.
Source: Spotlight Education
In response to the shifting pattern in the UK labour market, REC chief executive Kevin Green said:
"...It's clear that employers are having to work even harder to fill jobs as vacancies rise and candidate availability shrinks. The parts of the economy most reliant on European workers are under even more pressure as many EU workers return home. Employers are not just struggling to hire the brightest and the best but also people to fill roles such as chefs, drivers and warehouse workers..."
So, look again at the labour supply and demand chart: if the supply of labour were to contract as fewer EU workers choose to remain here then even if the elasticity of labour supply is unchanged, a higher wage rate, W3, will emerge at a lower level of employment, i.e. Q3.
Source: Spotlight Education
If we move back from the world of economic theory to the real UK economic situation official data from the ONS have indicated that the growth of average weekly earnings across the UK has been slowing down. Earnings are now only 1.8% higher than a year ago which is the slowest rate of increase since late 2014. This has contributed to a cut in real incomes because the rate of inflation has been higher.
However, before we ditch the theoretical model one should note that REC said some of its members had noted that employers were now making a move to offer higher pay rates to lure the right recruits across all monitored UK regions, with the steepest rate of increases seen in the South of England. Indeed, one can see that from the Markit report we see pay rates for permanent jobs are now rising as a result, and are in fact now running at a 20-month high.
Source: ONS, Spotlight Ideas
The data presented in the chart above should be seen in two stages. The latest data from mid-2015 shows wage growth making a slow and steady periodic increase averaging 2.5%. In contrast, the path of inflation has been making steady gains and has surged since June 2016 as the UK voted to leave the EU.
With a front-end weighting model to place more value on more recent data, the correlation of wage growth and inflation for the whole period illustrated is meaningless at just 0.0107. However, run the data again up to July 2014 and a figure for R-Squared emerges at 0.4579.
I think the labour market is about to see a jump in wages at a time when through to December inflation should taper off a little as the shock of Brexit, the fall of sterling, and the rising cost of imports starts to drop out of the inflation calculation.
Then if the correlation of 0.4579 is re-established and wages drive inflation unless UK productivity radically improves I think we will see the Bank of England facing heightened pressure to raise rates during Q1 2018.
I suggest we all keep a close eye on wage rates and inflation as all pan-European portfolios may need to rethink the degree of exposure/weighting assigned to the FTSE 100 and the Gilt market in the next six months.
— Edited by Michael McKenna