With their unemployment-based guidance strategy in tatters, MPC members are shifting focus to weak average earnings growth, as well as recent sterling strength, to defend their refusal to raise Bank rate. Official earnings numbers, however, may understate current pay expansion.

The chart below shows annual growth in three average income measures:

1.    The official average weekly earnings series;
2.    An alternative average pay measure derived by dividing aggregate wages and salaries in the national accounts by the number of employees in employment;
3.    A broader measure of average income from economic activities including self-employment earnings and small business profits*.

The national accounts based average wage measure rose by an annual 1.9% in the third quarter of 2013, significantly faster than official average earnings growth of 0.8%. The broader measure including non-wage income expanded by 3.1%.

Annual growth of all three measures was depressed in the first quarter of 2013 and boosted in the second quarter by late payment of bonuses to take advantage of the cut in the top rate of income tax last April. The third quarter numbers, however, should be undistorted.

The difference between the two average wage measures partly reflects recent stronger growth in jobs than employee numbers. The official earnings series is measured on a per job basis but more people now have several positions – the total number of workers with a second job rose by 4.3% in the year to the third quarter and reached a 12-year high in the latest three months**.

The recent stronger growth of the alternative average wage and total income measures aligns with survey evidence of improving household finances, as well as solid consumer spending expansion.

The chart shows that divergences between the series can be significant but are temporary – their long-term growth rates are almost equal. The expectation here is that the current gap will be closed by a pick-up in the official average earnings measure during 2014.

*Wages and salaries plus the household sector’s gross operating surplus and gross mixed income divided by total employment.
**Includes self-employed. 1,176,000 or 3.9% of workers reported having a second job in the three months to November.

Inflationary risks from the labour market are building as weak productivity performance contributes to a rapid erosion of slack.

Employment continued to boom in late 2013, with a favourable full-time / part-time split. Aggregate hours worked surged by 1.1% in the three months to November from the prior three months. With GDP growth likely to have fallen short of this level in the fourth quarter – a preliminary estimate will be released on 28 January – the suggestion is that productivity weakened further in late 2013, following a 0.3% decline in the third quarter.

Unemployment trends, meanwhile, make a mockery of Bank of England forecasts that were revised significantly just two months ago. The unemployment rate fell sharply again to 7.1% (7.15% unrounded) in the three months to November, to stand 0.5 percentage points below the Bank’s fourth-quarter projection in the November Inflation Report. The current rate was expected to be reached only in late 2014.

The vacancy rate – i.e. the number of unfilled positions expressed as a percentage of employee jobs – is an employer-based measure of labour market tightness and rose to 2.0% in the fourth quarter, slightly exceeding its average since 1995*. The vacancy rate is positively correlated with the annual rate of change of inflation-adjusted regular earnings: its normalisation suggests that real earnings will resume growth later in 2014 – see chart.

The forecast here remains for inflation to rebound later this year and in 2015 as rising real wages combine with sluggish productivity to push up unit labour cost expansion, with capacity pressures causing firms to protect or increase margins. The main risk to this view is a further surge in the exchange rate; the Bank is likely to use recent sterling strength as a reason to maintain its dovish interest rate guidance.

*The vacancy rate was estimated before the second quarter of 2001 by linking the current employer survey based vacancies series with an earlier series, ending in the first quarter of 2001, covering vacancies at job centres. This linking assumes that 1) the vacancy rate was unchanged between the first and second quarters of 2001 (reasonable – unemployment was little changed between the two quarters) and 2) job centre vacancies were a constant proportion of total vacancies from 1995 to 2001.

Job openings suggest that payroll employment will expand respectably early 2014 while there is less slack in the labour market than Federal Reserve policy-makers believe.

Job openings lead employment and rose to a new recovery high in November – see first chart. This supports the view that December payrolls weakness was weather-related rather than fundamental, implying likely positive pay-back in early 2014.
 
The ratio of openings to employment, i.e. the vacancy rate, is an employer-perspective measure of labour market slack. It now stands at 2.9% versus a 2.7% average since December 2000, when the openings data start – second chart. Employers, in other words, are finding it more difficult to recruit suitable workers than on average over the last 13 years. This accords with survey evidence of rising skill shortages.

The current vacancy rate matches levels in the first halves of 2008 and 2005; the unemployment rate averaged 5.2% in both periods. With the jobless rate at 6.7% in December, this suggests that “structural” unemployment has increased by as much as 1.5 percentage points of the labour force since the late 2000s. If so, the Fed is optimistic in believing that the unemployment rate can fall to about 5.5%* without generating inflationary labour cost pressures.

*The “central tendency” forecast of Fed governors and regional presidents for the unemployment rate “in the longer run” is 5.2-5.8%.

Six-month expansion of global real narrow money* is estimated to have recovered in December, though remains lower than last spring. Allowing for the typical half-year lead on the economy, the suggestion is that output growth is at a peak currently but will stay solid through mid-2014.

December monetary data have been released for the US, Japan, China, India and Brazil, together accounting for about 60% of the global aggregate monitored here. Assuming constant six-month rates of change in other economies, global real money expansion rose to 3.1% (not annualised) last month from 2.3% in November. The December estimate is incorporated in the first chart, which also shows industrial output growth through November.

The December improvement does not alter the assessment here that 1) global economic growth is at or close to a peak currently and 2) there is no longer “excess” liquidity available to power generalised financial asset price inflation. Six-month real money expansion is below its level last spring (3.7% in May) and the previous gap with output growth has closed.

The December rise was driven by the US, China and India. Real money trends slowed further in Japan and remain negative in Brazil – second chart.

The final December global number will depend importantly on Eurozone results released on 29 January. The annual update of US seasonal factors this week may also affect the recent profile.

*Global = G7 plus E7 large emerging economies. Narrow money refers to forms of liquidity held by households and firms, excluding banks, that can be used in immediate settlement of transactions. Country definitions vary but include, at a minimum, currency and demand deposits while excluding time deposits and notice accounts. Narrow money should be distinguished from the monetary base, comprising currency and bank reserves with the central bank.