Earnings Rise as Unemployment and Employment Both Continue to Climb in U.K.

Latest labour-market data from the Office for National Statistics (ONS) are mixed, showing unemployment continuing to increase, but also employment rising to a record-high level. Overall, however, it is evident that the improvement in growth since the last quarter of 2005 has still not been sufficient to generate enough jobs to cater for the growing workforce. In addition, many companies remain keen to keep their labour forces as tight as possible because of the significant squeeze on their margins stemming from high input costs and a limited ability to pass on these costs as a result of of intense domestic and international competition. This is particularly the case in the manufacturing sector.

Claimant Count Unemployment Rose at Reduced Rate

Claimant-count unemployment (those seeking Jobseekers' Allowance benefits) climbed by a further 2,000 in July. This was the smallest increase since unemployment started rising in February 2005, and was down from an increase of 4,300 in June. Indeed, the rise in unemployment on the claimant count measure has been trending down recently, as the number of jobless increased by 17,200 in the second quarter of 2006 (a monthly average of 5,700) compared with a jump of 29,900 (a monthly average of 9.967) in the first quarter. Nevertheless, July's increase took the number of jobless up to 957,000, which was the highest level since January 2002. This was up from 907,900 at the end of 2005 and a near-30-year low of 819,000 in February 2005.

The national claimant-count unemployment rate remained at 3.0% in July, having originally risen to this level in March from 2.9% in February. This is the highest level since October 2003. The unemployment rate had previously risen to 2.9% in December 2005 from 2.6% at the end of 2004.

Unemployment Also Up on ILO Measure

Unemployment also increased on the ILO measure. Specifically, it rose by 92,000 in the three months to June, compared with the three months to March. This took the average number of jobless on the ILO measure up to 1.677 million during April-June, from 1.586 million in January-March and a low of 1.392 million in July-September 2004 (the lowest level since comparable results were recorded in 1984). The ILO count includes those out of work and not drawing unemployment benefits and is the primary measure by which international comparisons are drawn. The ILO unemployment rate rose to 5.5% in April-June. This was the highest level for six years, and up from 5.2% in January-March and 4.8% a year earlier. In addition, the ONS revealed that 139,000 people reported that they had been redundant in the three months to June, which figure was down from 144,000 in the three months to March.

But Employment at Record High

However, there was also some good news on the labour market. Indeed, employment rose by 42,000 to average a record 28.938 million in the three months to June, according to the ILO. Furthermore, employment was up by 240,000 year-on-year (y/y) in the three months to June. That there has largely been the unusual occurrence of both employment and unemployment rising is a consequence of the labour force being lifted by an increase in the working-age population. The rising working-age population reflects a greater number of older people staying in the workforce, an increase in the number of previously economically inactive people now looking for a job (particularly women), and a substantial amount of immigrant workers. The employment rate for people of working age (16-64) stood at 74.6% in April-June. This was down marginally from 74.7% in January-March and also 74.7% a year earlier.

The number of employed has been significantly boosted by increased demand for public-sector workers, reflecting the government's attempts to improve public services, particularly health and education. However, the government is now beginning to reduce the overall funds that it is channelling to public services, and it is also aiming to reduce substantially the number of civil-service jobs by 2008. Meanwhile, the number of part-time workers was unchanged at 7.339 million in the three months to June, compared with the three months to March. It was up 10,000 in y/y terms.

Manufacturing Employment Fell Again

In contrast to the marked rise in overall employment, manufacturing employment declined by a further 3,000 to a record low of 3.04 million in May. This brought the total loss in manufacturing jobs to 41,000 in the first six months of 2006, following a drop of 106,000 in 2005. Although the manufacturing sector has seen significant overall improvement so far in 2006, it has largely struggled to sustain any upturns in recent times. Meanwhile, manufacturers' margins are being particularly sharply squeezed by high input prices and intense competition. Consequently, manufacturers remain keen to keep their labour forces as tight as possible. Nevertheless, the fact that manufacturing payrolls fell by a substantially reduced 9,000 in the second quarter of 2006 compared with a drop of 32,000 in the first quarter boosts hopes that the sector's recently healthier performance could be increasingly causing companies to stop shedding jobs. Furthermore, the latest purchasing managers' survey for the manufacturing sector showed that employment in the sector expanded for the third time in four months in July, albeit marginally. These were the first increases in employment in the sector since March 2005.

Earnings Rise

The ONS also reported that headline annual average earnings growth climbed to 4.3% in the three months to June 2006 from 4.1% in the three months to May. This was the equal highest increase in average earnings since the three months to April 2005. The rise in average earnings was significantly boosted by earnings climbing by 5.0% y/y in June itself as higher bonuses were paid in the financial sector.

Underlying annual average earnings growth (which excludes bonuses) edged up to 3.9% in the three months to June, from 3.8% in the three months to May and a near two-year low of 3.7% in the three months to April. Excluding bonuses, private-sector earnings increased 4.2% y/y in the three months to June, while public-sector earnings were up by just 2.7% y/y. However, underlying annual-average-earnings growth climbed to an 11-month high of 4.1% in June itself, from 3.9% in May, and 3.6% in April.

Outlook and Implications

Underlying annual-average-earnings growth is still relatively muted and clearly below the 4.5% level considered consistent with the Bank of England's 2.0% consumer price inflation target. Nevertheless, the latest data suggest that earnings could be beginning to creep up.

Certainly, there is a risk that pay could move higher over the coming months. Headline retail price inflation (upon which many pay settlements are still based on) rose to 3.3% in June and then remained at that level in July. This was the highest level since December 2004, and up from 3.0% in May, 2.4% in March, and a 38-month low of 2.2% in December 2005. In addition, while the very latest surveys have shown a modest easing back in the public's inflation expectations, they are still clearly higher than they were through 2005.

However, we believe that wage moderation is likely broadly to continue as workers' bargaining power over pay continues to be limited by the recent increase in the labour force and rising unemployment.

There are indications in the reduced fall in claimant count unemployment in recent months, as well as in the further rise in employment during April-June, that the labour market is beginning to benefit from the healthier economic growth seen since the latter months of 2005. Latest survey evidence is also indicating limited labour-market improvement. Nevertheless, we expect both employment and unemployment to rise further over the coming months, as the economy mostly experiences no more than trend growth. Furthermore, the continuing squeeze on many companies' margins coming from strong input prices (pushed up by high oil, energy and commodity prices) is encouraging many companies to try to contain costs by keeping their labour forces as tight as possible.

The combination of rising unemployment and muted earnings growth is expected to limit the upside for consumer spending over the coming months, although higher employment will obviously provide some support. Muted earnings growth is also a significant factor underpinning our belief that the housing market will not be able to sustain significant gains for an extended period.

Meanwhile, the Bank of England will closely monitor pay developments. If earnings do continue to creep up over the coming months, the odds of another interest-rate hike before the end of the year will rise markedly.