13 March 2024: The Labour market is cooling

Yesterday’s publication of employment data provided yet another twist to the seemingly endless saga of the timing of an interest rate cut by the Bank of England.

Earlier this month, following the Budget it had been assumed that with inflation still being “sticky”, the Bank would hold off on a rate cut, particularly since the economy had seemingly come out of recession as quickly as it went in.

Now, the jobs data shows that the labour market is cooling, likely in response to the level of interest rates. This is a far longer-term effect of monetary policy and may lead to a change of view, although there are several “voices” on the MPC who are calling for rates to be kept “higher for longer.”

The Bank’s Chief Economist, Huw Pill, commented that he felt that the first cut in interest rates is still “some way off”, while the Committee’s arch-hawk, Catherine Mann spiked only yesterday because of her belief that rates need to remain at their current level until there is solid evidence that inflationary pressures are consistent with the Bank’s 2% target.

While the UK may not now be in recession, data published later this morning will go a long way to confirming that, the employment data resembles tion heading in that direction.

Having added 72k new jobs over the three months to January, the economy shed 21k jobs in the three months to February, indicating a significant slowdown in job creation. This is a classic sign of an economic contraction.

The claimant count rose to 16.8k following a revised figure of 3.1k in January.

Of further concern for the Bank of England, should it now consider a cut in interest rates, was the fact that increases in average earnings, whether bonuses are included or not, are still rising at a level that is higher than headline inflation.

That will add to the stickiness of price rises since firms cannot lower prices for their goods and services shortly.

The data points to the fact that the weakness of the economy over the past six months has taken a greater toll than had been realized.

Conversely, more recent business surveys are showing a slightly renewed confidence in the economy going forward. This will mean that next week’s MPC meeting and the one following will be closely watched for any sign the Bank is leaning towards a less hawkish outlook for monetary policy.

The contrast between the UK employment report and the U.S. inflation report, which was also published yesterday, saw Sterling come under renewed pressure following its recent rise.

The pound fell to a low of 1.2746, but it rallied to close at 1.2792.

Yesterday’s publication of the February inflation report “nailed” any lingering consideration that the FOMC will vote to cut the Fed Funds rate at its meeting next week.

As many observers noted, inflation now appears to be moving sideways not down despite interest rates remaining at their highest level for more than a decade.

There continue to be several drivers that are affecting inflation that monetary policy has little bearing upon. The war in Ukraine continues to push the price of several foodstuffs on the world market higher, while attacks by Houthi Rebels on shipping in the Gulf of Aden and the Red Sea add to shortages and raise demand.

The Fed’s commitment to the “long haul”, with Jerome Powell particularly concerned that an “early” rate cut may undo the somewhat arduous work that the Fed has undertaken over the past year to gain control over inflation.

While it can be said that the hard work has paid off, several members of the FOMC still want to see the current “plateau” for inflation broken before committing to a rate cut.

The data released yesterday showed that inflation is still at 3.8% following price rises of 3.9% in January. With last week’s employment report showing that average earnings rose to 3.9%, the Fed will still need to see progress, which could take until the end of the second quarter.

J.P. Morgan CEO, Jamie Dimon, who has been one of the most prominent economic “bears” over recent months, still believes that the economy could be heading for a recession. He spoke yesterday of his fear that a recession is not “off the table”, although conversely, he also cautioned the Fed against being “hasty” in cutting interest rates.

He still believes that a soft landing for the economy is still 70% to 80% priced in, but he still fears a period of stagflation in the next two years.

The dollar index finally reacted predictably to the inflation report and its ramifications for interest rates.

It rose to a high of 103.17 and closed at 102.92, confirming its short-term low had been achieved.

While the ECB is determined to win its “war” against inflation, there is another crisis building that will be just as important, but the Central Bank will need the help of the European Commission to win.

The entire Eurozone economy needs a reboot and changes to its structure if it is to be fit for purpose in the coming years.

The time for the Eurozone to be considered an experiment is over. It has made greater strides in incorporating twenty diverse economies into a monetary union, the next stage needs to be a more “Federal” region with unified policies on defence, employment, and taxation.

One of the reasons that the battle against inflation has been so convoluted is that several monetary policy decisions have been “watered down” by individual Eurozone members “going their way” over fiscal policy.

Italy has enacted several changes to its social policies over the past year which have driven its debt-to-GDP ratio above 150% while its budget deficit is approaching 5%.

Although it is displaying an almost total disregard for fiscal discipline, Italy has revised its output data for the second half of 2023, and it has now made the “best” recovery of any major economy in the region.

The economy is now 4.2% larger than it was pre-pandemic in Q4 2019. Italy was the first Eurozone nation to see Covid-19 arrive, and its lockdowns lasted appreciably longer than its neighbours, so while its recovery is impressive, it is also to be expected, particularly when the “super bonus” of tax relief on home improvements is taken into consideration.

This Italian “miracle” cannot go on forever. The re-introduction of the growth and stability pact, no matter what form it takes, may see these fiscal policies quickly withdrawn or reversed, which would signal unwelcome news for Giorgia Meloni and her government.

Another long-term concern for the Eurozone economy is the widening productivity gap between the region and the U.S. The EU faces what is being labelled a “competitiveness crisis” due to a lack of both public and private investment.

Eurozone productivity fell by 1.2% in the fourth quarter of 2023. This compares unfavourably with the U.S., where over the same period it rose by 2.6%.

Overall, the Eurozone economy is less efficient than its U.S. counterpart, and well below the levels of efficiency being seen in China.

This may lead to a long, slow decline for the Euro as export growth fades.

Yesterday, the single currency ended the day almost unchanged at 1.0926 having earlier declined to 1.0902, as the market now sees the ECB cutting rates before the Fed.

Have a great day!