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Unemployment falls to 42-year low, but real earnings continue to decline

Ben Brettell, Senior Economist, Hargreaves Lansdown:

First the good news: unemployment fell to 4.5% in the three months to May – the lowest since 1975. There were more than 32m people in work, 324,000 more than a year earlier.

However, the squeeze on household finances continues, with wages growing by less than inflation for a third consecutive month. Pay (including bonuses) grew by 1.8%, meaning that after inflation, average earnings in the three-month period fell by 0.7% compared with a year earlier. June’s inflation figures aren’t released until next Tuesday (18 July).

Shrinking real pay doesn’t bode well for economic growth – the UK economy is heavily reliant on the consumer and falling real incomes should eventually translate into lower retail sales. Respected think-tank NIESR said last week it expects relatively anaemic growth of 0.3% in the second quarter – barely higher than the disappointing 0.2% registered in Q1.

The UK labour market is becoming increasingly difficult to interpret. Conventional economic theory suggests that low unemployment should ultimately lead to upward pressure on wages – but there has been scant evidence of this during the latest squeeze on household finances. Perhaps workers simply don’t have the bargaining power they once did.

Wage growth is one of the Bank of England’s key metrics when setting interest rates, as higher wages can ultimately create upward pressure on prices. Weak pay growth makes it increasingly likely interest rates will be held at 0.25% for now – a view reinforced yesterday by BoE deputy governor Ben Broadbent, who declared he isn’t yet ready to vote for higher rates. His comments sent sterling tumbling to an eight-month low against the euro.