UK reports payroll gains, coupled with striking pay growth figures

Chris Scicluna

Equity markets mixed in Asia: up in China as data provides some comfort, but down in Japan and Australia as pandemic worries weigh
While Tuesday’s blowout US CPI was followed by a similar big upside surprise in the PPI yesterday – the core inflation rate rising a much steeper than expected 0.8ppts to 5.6%Y/Y – there was little reaction in bond markets, with investors clearly focused on Jay Powell’s impending semi-annual testimony before the House Financial Services Committee. And with Powell repeating his post-FOMC remark – as he was bound to do – that the employment and inflation conditions needed to begin tapering QE purchases were “still a ways off”, the Treasury market proceeded to erase its post-CPI gains, with the 10Y UST yield finishing 7bps below the previous day’s close at 1.35%. So despite some volatility during the session, the S&P500 closed with a modest 0.1% gain while the decline in UST yields weighed on the greenback.

Since the close, both US equity futures and the UST yields have slipped a little lower. Against that background, it has been a mixed day in Asia, where most of the focus has been on the latest Chinese economic data. That data painted China’s recent economic momentum in a stronger light than the market had expected, with sequential GDP growth rising in Q2 and the main domestic economic indicators for June all beating expectations. So as we write, stocks in Mainland China, Hong Kong and Taiwan are materially firmer. Meanwhile, Chinese bond yields are also slightly higher, with the PBoC today conducting a CNY100bn MLF operation – to replace only part of a CNY400bn maturity – at an unchanged rate of 2.95%. This indicates that the 1Y and 5Y prime benchmark lending rates will also be held steady next week.

Elsewhere, gains are also being recorded in South Korea, even as the BoK left its key policy rate at 0.5% as expected, but indicated that a rate hike would be discussed at next month’s meeting, citing a growing need to deal with financial imbalances (that said, understandably, Governor Lee noted that this discussion would also have to factor developments in the current virus outbreak). By contrast, ahead of tomorrow’s BoJ meeting – at which the Bank seems certain to cut its near-term GDP growth forecast – the TOPIX has declined 1.2%, with an earlier decline extending after news of a far sharper than expected 2.7%M/M slump in service sector activity in May raised the prospect of a materially negative GDP outcome for Q2. And with new cases in Tokyo approaching a six-month high in recent days, the prospects of a material rebound in the economy in the current quarter appear to be fading.

Equity markets have also weakened a little in Australia – and AGCB yields have tracked UST yields lower – despite welcome news of a further unexpected decline in the unemployment rate in June to a more than 10-year low of 4.9%. The report did point to a drag on hours worked from Victoria’s last lockdown (albeit hours worked still increased a sturdy 2.9%Q/Q in Q2). And unfortunately, according to local media, Victoria seems set to enter a new snap lockdown from midnight local time tonight, due to growing cases linked to the Sydney outbreak (Sydney reported just 65 new cases today, but case numbers are expected to rise in coming days with almost half of those new cases infectious in the community).

China’s GDP grows 1.3%Q/Q in Q2 – above expectations, although annual growth a touch below consensus at 7.9%Y/Y due to revisions
The focus for investors in the Asian time zone has been China’s release of the national accounts for Q2, together with key domestic activity indicators for June. In summary, these reports pointed to an economy that had more momentum than expected during the quarter – especially at the end of the quarter – although downward revisions to growth in previous quarters meant that annual growth was a notch below the consensus forecast.

After growing just 0.4%Q/Q in Q1 – revised down 0.2ppts – the economy grew 1.3%Q/Q in Q2, which is not too far below the trend that the government is now seeking. This result is consistent with the pick-up in the average PMI level through the quarter, even with sporadic outbreaks of the virus and associated restrictions continuing to depress activity. Due to base effects – the economy had already rebounded sharply in Q2 last year – annual growth slowed to 7.9%Y/Y from a very elevated 18.3%Y/Y in Q1. This outcome was a tenth below the survey expectations, reflecting downward revisions to growth in earlier quarters. According to the NBS, activity in the service sector grew 8.3%Y/Y, outpacing growth in the manufacturing and primary sector (7.5%Y/Y and 7.6%Y/Y respectively).

China’s activity indicators for June all exceed market expectations
Turning to China’s monthly indicators, the surprises were much as signposted by the stronger-than-expected export and import data released on Tuesday. Beginning with the industrial sector, total output increased 0.6%M/M in June, which was fractionally stronger than over the previous two months. Base effects associated with last year’s rebound in output from the lockdown meant that annual growth slowed to 8.3%Y/Y from 8.8%Y/Y in May, but this outcome was still 0.4ppts firmer than the consensus expectation. For the year to date, industrial output increased 15.9%Y/Y following a 1.3%Y/Y decline a year earlier. In the detail, manufacturing activity grew 8.7%Y/Y in June, whereas mining and quarrying activity grew just 0.7%Y/Y. On an industry basis, unsurprisingly, the standout was pharmaceuticals where output has increased 32.5%Y/Y). Production of metal products grew 19.7%Y/Y while production of machinery grew 15.0%Y/Y. Power generation increased 11.6%Y/Y following a 5.5%Y/Y increase a year earlier.

Turning to the demand side of the economy, while growth in retail spending slowed 0.3ppts to 12.1%Y/Y in June, this was 1.3ppts firmer than the consensus expectation. , albeit this growth follows a drop of 7.5%Y/Y a year earlier. For the year to date, retail sales increased 23.0%Y/Y, albeit coming off the back of an 11.4%Y/Y decline a year earlier. Growth in catering services slowed to 28.6%Y/Y from more than 40%Y/Y in May. However, growth in spending on goods strengthened to 11.2%Y/Y from 10.9%Y/Y previously. Meanwhile, investment spending on non-rural fixed assets increased 12.6%YTD/Y in June, which was down from 15.4%YTD/Y in May but still 0.6ppts firmer than the consensus expectation. Growth in private sector investment slowed to 15.4%YTD/Y, whereas growth in state investment slowed to 9.6%YTD/Y. Manufacturing sector investment grew 19.2%YTD/Y, albeit coming after an 11.7%YTD/Y decline a year earlier. Property development increased 15.0%YTD/Y, which was down from 18.3%YTD/Y last month and a little below market expectations. Finally, consistent with a sense that the economy was growing at around a trend pace, the urban unemployment rate was stable at 5.0% in June.

In other news, new home prices across China’s 70 largest cities increased 0.41%M/M in June, marking the smallest increase since March. As a result, annual growth in prices slowed 0.2pts to 4.3%Y/Y. Existing home prices increased 0.28%M/M, which was similar to last month, and left annual growth steady at 3.5%Y/Y. As in previous months, price pressure is much more intense in so-called first-tier cities, where new home prices increased 0.7%M/M/6.2%Y/Y and existing home prices increased 0.7%M/M/10.5%Y/Y (with prices in Guangzhou up 13.2%Y/Y).

Japan’s service sector activity slumps 2.7%M/M in May, raising likelihood of material GDP contraction
Following yesterday’s downward revision to IP in May – albeit leaving activity on track for modest growth in Q2 – today METI delivered some bad news regarding activity in the service sector. Following a 0.8%M/M decline in April that was a tenth worse than reported previously, the Tertiary Industry Activity Index slumped 2.7%M/M in May. Given the very weak base created by the onset of the pandemic last year, activity was up 10.3%Y/Y. However, given the decline in May – which was triple the consensus expectation – activity has returned to the lowest level since July last year. And given the likelihood of no more than a modest rebound in June as restrictions eased somewhat – albeit temporarily in the Tokyo area – activity across Q2 as a whole seems on track to do no better than repeat the 0.7%Q/Q decline that occurred in Q1.

In the detail, unsurprisingly, the decline was led by activity related to non-essential personal services, which fell a further 5.0%M/M in May following a 4.5%M/M decline in April – now almost 19% below the pre-pandemic level in February 2020. Activity related to essential personal services declined 2.9 while that related to business services fell 2.7%M/M. By industry, also unsurprisingly, the largest decline was an 8.1%M/M slump in activity related to living and amusement services. Activity related to information services also fell a steep 7.7%M/M, albeit coming after a more than 16%M/M jump in April. Wholesale trade, medical and welfare services and transport services were also very weak in April.

After Ramsden’s more hawkish comments, UK labour market data show further payroll gains in June, with striking pay growth flattered by temporary factors
After yesterday’s upside surprise in the latest UK inflation data, BoE Deputy Governor Jon Cunliffe took a measured approach, suggesting that the pressures were likely to be transitory but noting that the Bank would re-evaluate the outlook next month when it updates its projections. Yesterday evening’s remarks from his fellow Deputy Governor Dave Ramsden struck a somewhat more hawkish tone than of late, however, flagging that inflation could rise close to 4%Y/Y for a period later this year, suggesting that the risks of inflation remaining persistently above-target had increased, and thus noting that he “can envisage the conditions for considering tightening being met somewhat sooner than… previously expected”. External MPC member Saunders will add to the chorus of voices from the BoE when he presents on the inflation outlook later this morning.

With both Cunliffe and Ramsden having underscored the importance of assessing the relative balance between supply and demand, this morning’s labour market data will inevitably be closely scrutinised by the BoE. But they were very much a mixed bag. With the government’s Job Retention Scheme still in full operation up to the end of last month and the economy continuing to return to some form of post-lockdown normality, it was no surprise to see the number of payroll employees post another monthly increase, up 356k (1.3%) in June to 28.9 million. That left it some 206k (0.7%) below the pre-pandemic level. But for the first time since the outbreak of Covid-19, the ONS reported that payrolls in some regions (the North East, North West, East Midlands and Northern Ireland) had risen above the pre-pandemic level. In the three months to June there were also 862k job vacancies, 77.5k above the pre-pandemic level. On the (somewhat lagging) ILO measures, which were affected by methodological changes, the unemployment dropped 0.2ppt in the three months to May to 4.8%, while the employment rate edged up 0.1ppt to 74.8%. However, the three-month increase in employment of 25k in May was significantly lower than expected and indeed the weakest since February.

The headline rates of wage growth were striking. Growth in average total pay (including bonuses) in the three months to May rose 1.6ppts from the three months to April to 7.3%Y/Y with growth in regular pay (excluding bonuses) up 0.9ppt to 6.6%Y/Y. However, these figures remain exaggerated by temporary factors, notably compositional and base effects. Indeed, the ONS estimates that the base effect accounts for between 1.8-3.0ppts of the increase, with the compositional effect adding perhaps 0.4ppt. So, it judges that the underlying rate of pay growth currently lies somewhere between 3.2-4.4%Y/Y, a rate that should be of far less concern to the BoE.

Final Italian CPI due on a quiet day for euro area data
A quiet day for euro area releases brings just the final Italian CPI figures for June. Like Tuesday’s German and French results, but in contrast to yesterday’s upward revision to Spanish inflation – by 0.1ppt to 2.5%Y/Y, a more-than four-year high on the HICP measure – the Italian data are expected to confirm the flash estimates. These revealed that the EU-harmonised measure of inflation rose 0.1ppt from May to 1.3%Y/Y. This in part reflected higher energy inflation (14.4%Y/Y), while the decline in food prices also moderated (-0.3%Y/Y). But services inflation (up 0.1ppt to 0.3%Y/Y) was boosted by higher restaurant and hotel costs on the back of pandemic-related base effects (from 0.1%Y/Y in May to 1.5%Y/Y) and non-energy industrial goods inflation rose 0.2ppt to 0.3%Y/Y. So, core inflation (on the EU HICP measure) was up 0.2ppt from May albeit at a still exceptionally low 0.3%Y/Y.

Focus turns to the manufacturing sector in the US today; Powell before the Senate
From today, attention in the US turns mainly to indicators of activity. Most interest today is focused on the factory sector, and especially on the IP report for June. Daiwa America’s Mike Moran estimates only a modest 0.4%M/M lift in activity this month, with labour market data pointing to a relatively soft outcome in the manufacturing sector (mining and utility output are likely to be much stronger, however). Further indications regarding the trend in manufacturing activity will be provided by the release of Philadelphia and New York Fed manufacturing surveys for July, while data on trade prices for June is also scheduled for release today. Following yesterday’s testimony in the House, today Jay Powell will testify before the Senate Banking Committee. In addition, bank earnings will remain a key focus for investors, with Morgan Stanley and BNY Mellon amongst the institutions reporting their quarterly results today.

Aussie unemployment rate falls 0.2ppts to 4.9% – lowest since December 2010
As far as data were concerned, the domestic focus in Australia today was on the labour market. Following a stellar 115k lift in May, employment grew at a somewhat more sedate pace of 29.1k (0.2%M/M) in June, although this still exceeded the consensus forecast by 9k and is around double the long-term average. With employment a year earlier having already begun to recover from the first lockdown, annual growth in employment slowed to 6.3%Y/Y from 8.1%Y/Y previously. More meaningfully, employment sits 1.2% above the pre-pandemic high registered in February 2020.

In the detail, full-time employment increased by an especially encouraging 51.6k in June, building on a near 98k lift in May. As a result, full-time employment is now up 5.7%Y/Y and 1.7% higher than in February 2020. By contrast, part-time employment declined 22.5k in June but was still up 7.6%Y/Y. This month employment growth was concentrated in Queensland and Western Australia, whereas employment fell modestly in New South Wales and Victoria – the latter impacted by lockdown restrictions for a period during the month. Victoria’s lockdown led to an 8.4%M/M decline in aggregate hours worked in that state, which more than accounted for a 1.8%M/M decline at the national levels. Even so, hours worked increased 6.8%Y/Y from the depressed level recorded a year-earlier. And perhaps more importantly, despite the decline in June, hours worked grew a considerable 2.9%Q/Q in Q2.

The labour force participation rate was steady at 66.2% in June, and so remains just below the record high reached in March. As a result, growth in the labour force was insufficient to soak up the increase in employment, causing the unemployment rate to decline by a further 0.2ppts to 4.9% – the eighth consecutive decline that has reduced the unemployment rate to the lowest level since December 2010. However, the underemployment rate – which captures those who are working less hours than they would like or in jobs for which they are overqualified – increased 0.5ppts to 7.9%. According to the ABS, this increase – from what had been the lowest reading since January 2014 – is mainly due to impact of Victoria’s lockdown on hours worked.

So all up, this report continues to point to considerable momentum in the labour market, as had been suggested by job vacancy and advertising data and business survey indicators. In its last forecasts back in May, the RBA had forecast the unemployment rate to decline to 5¼% by the end of Q2 and 5% by the end of Q4. So with the unemployment rate now below the Bank’s year-end forecast, the RBA will (again) have to revise down its forecast for the unemployment rate when it releases its updated forecasts next month. Of course, Governor Lowe has made clear that he believes that an unemployment rate in the low 4s will likely be needed to drive the 3% plus wage growth that he thinks will be necessary to sustain CPI outcomes in line with the Bank’s target. At the present pace of improvement – if not moderated by the virus outbreak – such a level could be seen within the next year, which would clear lower the barrier for the Bank to respond to a rise in CPI inflation much sooner than the 2024 timeframe that Lowe presently as in mind.

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