Labour market statistics released today are a mixed bag, showing stronger quantity developments than forecast by the MPC but surprisingly low earnings growth. Earnings weakness may not prevent the MPC from turning more hawkish, partly because it reflects sluggish productivity.

The unemployment rate fell to a below-consensus 6.6% over February-April, with the April single month estimate at just 6.45% – see first chart. This supports the forecast here that the rate will finish 2014 at 6.0% or below, undershooting the May Inflation Report projection of 6.3% in the fourth quarter.

The jobless rate is plunging because of strong demand for workers rather than US-style labour force weakness. Aggregate hours worked in the economy rose by 3.3% in the three months to April from a year before – the fastest annual growth rate since 1989. With the Inflation Report projecting a 3.6% GDP increase in the year to the second quarter, the suggestion is that productivity, as measured by output per hour, has barely budged. The MPC’s forecast of 1% productivity expansion in 2014, implying a larger rise in the year to the fourth quarter, is off track.

Annual growth in average earnings has been distorted by income shifting a year ago to game the cut in the top income tax rate from 50% to 45%. Taking a six-month moving average to minimise this distortion, earnings are rising at about a 1% annual pace. This is probably about 1 percentage point below the MPC’s expectation at this stage but, as noted, productivity is undershooting by a similar amount.

Part of the story is a shift of employment into lower wage / productivity activities over the past year. Earnings growth would be 0.5 percentage points higher in the absence of this composition shift.

The MPC may downplay earnings weakness partly because of the productivity offset but also because more timely survey evidence suggests rising wage pressures, while slack is eroding faster than expected. From employers’ perspective, the claim that significant slack remains is inconsistent with emerging skill shortages and a further rise in the vacancy rate to a six-year high – second chart.