UK economy stable in 3m to May, while labour market shows signs of cooling

The additional bank holiday for the King’s Coronation reduced the number of working days in May and so lowered GDP accordingly, with GDP falling by 0.1%. This left output flat overall in the quarter to May. But a smaller-than-expected decline points to underlying resilience, in line with the CBI’s recent surveys. The return to a normal number of working days in June suggests a likely rebound, raising the odds that the UK economy avoided a contraction in the second quarter. Meanwhile, although, earnings growth was higher than expected in the quarter to May, overall conditions cooled, with the unemployment rate up and vacancies down.

Is the glass half full or half empty?

This latest data from the ONS paints a fairly mixed picture for the UK economy. The economy saw no growth over the three months to May, but this was still better than was expected. Wage growth was also stronger than expected – for the three months to May, wage growth reached 7.7% for the private sector – but the unemployment rate rose to 4.0% and vacancies fell 84k, suggested demand for labour is easing. Overall, compared to a few months ago, wage and inflation data outturns with better activity data increase the likelihood that the Bank of England will increase interest rates further in the months ahead. Over the past month alone, market expectations for the peak in Bank Rate early next year have risen from 5.5% to 6.25%.

The latest set of labour market data for the quarter to May suggested that weak demand conditions over the past year have started to take their toll. Employment continued to move higher (by 102,000), but with the number of inactive people falling back further, the supply of workers expanded more rapidly than the demand for them, pushing the unemployment rate up to 4% (from 3.8% previously).

Nonetheless, the enduring strength of wage inflation is likely to draw the Bank’s eye. Average regular pay rose at the fastest pace on record (outside of the pandemic when the JRS distorted wage data), with robust growth in both private (7.7%) and public (5.8%) sector pay, reflecting the persistent strength of inflation and the (still) high number of job vacancies across the economy. This will worry the Bank’s Monetary Policy Committee (MPC), despite unemployment coming in higher than expected. Recent business surveys (including our own) suggest that firms expect wage growth to decelerate, but until the MPC sees this in official data they’re likely to retain a hawkish bias.

Altogether, recent data paints a picture of a stagnant economy dogged by high inflation and a labour market that is still tight from a historical perspective. This is broadly what we expected in our latest economic forecast, albeit with a couple more rate hikes now looking more likely. Looking ahead, we expect inflation to slow more rapidly in the months ahead, which will support household incomes. But given the countervailing trend of rising interest rates, growth is likely to remain fairly sluggish through the second half of the year, and downside risks have risen.