US job openings (vacancies) surged in April, consistent with the forecast here of economic reacceleration from the spring, following a rebound in real narrow money growth in late 2014 / early 2015 – see previous post.

The job openings rate (i.e. vacancies expressed as a percentage of the total number of jobs) rose to 3.7% in April, the highest since 2001. The official openings series begins at end-2000 but earlier numbers can be estimated from help-wanted data compiled by former Fed economist Regis Barnichon. The current openings rate is close to the 2000 cycle peak of 4.0% – see first chart.

The job openings rate is inversely correlated with the unemployment rate, leading the latter at turning points by an average of four months since 1970. The level of openings forecasts the flow rate of unemployed people into employment. A rise in this flow could, in theory, be offset by an increase in layoffs. Weekly initial unemployment claims, however, remain low, as does the monthly layoff tally compiled by Challenger, Gray and Christmas.

Based on the average four-month lead, the further rise in job openings suggests that the unemployment rate will continue to fall until August, at least. Mr Barnichon’s model, indeed, predicts that the jobless rate will smash through 5.0% over the summer, reaching 4.5% by end-2015.

The job openings rate is positively correlated with pay growth, as measured by the annual change in the wages and salaries component of the employment cost index (ECI), with a six-month average lead at turning points since 1983, when the ECI series begins. The recent pick-up in pay growth, therefore, may extend into late 2015, at least – second chart.

A recovery in the Fed’s preferred inflation measure – the annual change in the personal consumption chain price index excluding food and energy – from its April level of 1.2% is probably also required, but labour market trends are consistent with a September interest rate rise.

Domestically-generated inflation has risen and is above 2%

Domestic inflation is key because it determines where CPI inflation will settle when the effects of commodity price weakness and sterling strength dissipate.

A national accounts-based measure of domestic inflation is the annual increase in the deflator for gross value added (GVA), which measures the prices of goods and services produced in the UK. This rose to 2.2% in the first quarter of 2015.

The GVA deflator, moreover, has been suppressed by the fall in price of North Sea oil production. The GVA deflator excluding oil and gas rose by 2.7% in the year to the first quarter – the largest annual gain since 2009.

As well as signalling a likely strong rebound in CPI inflation, the rise in domestic inflation casts doubt on the MPC’s judgement that there is still slack in the economy (of about ½% of GDP, according to the May Inflation Report). Inflation should trend lower while slack persists, according to conventional doctrine.

The GVA deflator can be viewed, from the income side, as the sum of two components – employee compensation per unit of output and “other income” per unit of output. The large annual rise in the GVA deflator excluding oil and gas is accounted for by strength in the latter component – see first chart. Above-trend economic growth, in other words, has been reflected in upward pressure on corporate profit margins and self-employment incomes.

The danger is that the employee compensation component now takes up the running as wages pick up in response to a tight labour market. The annual change in unit compensation rose to 1.7% last quarter, the highest since 2013.



Economic growth is likely to remain above trend

The rise in domestic inflation would be of less concern if the apparent economic slowdown in early 2015 were to be sustained. Monetary trends, however, suggest that GDP growth will remain at around its 2013-14 level, which was associated with steady elimination of economic slack.

The second chart compares rates of change of GDP excluding oil and gas and measures of inflation-adjusted broad money (M4), narrow money (M1) and corporate money (M4 holdings of private non-financial corporations). The real money measures have given advance warning of economic fluctuations in recent years and their current growth rates are similar to or higher than in 2013-14.



Bank interest rates have fallen, delivering an effective monetary loosening

The MPC cut Bank rate to a minimum in 2009 partly to counteract a sharp rise in the spread between commercial bank deposit / lending rates and Bank rate in the wake of the financial crisis. The spread, however, has narrowed since 2012 as funding conditions for banks have eased, resulting in a 0.5 percentage point fall in the average bank interest rate vis-à-vis households – third chart.

Monetary policy was sufficiently loose in 2012 to produce solid economic growth in 2013-14. By keeping Bank rate stable as bank interest rates have fallen, the MPC has allowed an unwarranted further easing of domestic monetary conditions.

A possible counter-argument is that the impact of lower bank interest rates on monetary conditions has been offset by exchange rate strength, with the sterling effective rate rising by 8% since end-2012. The risk, however, is that this strength unravels rapidly. Historically, UK monetary policy-makers have frequently delayed necessary tightening because of concern about a temporarily high exchange rate, with inflation and interest rates subsequently rising significantly.