European stocks bounce back as UK employment data paints mixed picture

Sometimes there are data releases that the market does not know what to do with. This is the case with the latest UK labour market report. The unemployment rate ticked up to 4.4% from 4.3% in the three months to April, the highest rate since September 2021, suggesting that the labour market is loosening which is necessary for Bank of England interest rate cuts. However, wage growth jumped to 5.9%, which is far too hot to justify a rate hike. The June 20^th BOE meeting will be scrutinized for any suggestion of a late summer rate cut, however, it is worth noting that after that meeting the BOE will be in quiet mode until after the election.

The UK’s political hot potato: the inactivity rate

Politics matter for the Bank of England, especially as it, like other central banks, remain data dependent. It matters because it’s the politicians that will have to sort out the UK’s inactivity problem. The inactivity rate for people of working age rose to 22.3% between February and April, which is an increase on the prior quarter. More than 1 in 5 people in the UK are now not active in the labour market. This is causing a massive strain on the country’s finances, and it is also one reason why wage growth is so sticky. If employers can get the staff that they need, they don’t want to lose them so wage growth could remain elevated indefinitely. We doubt that any political party will address this problem head on in their election manifestos, however, getting people back to work is critical for the future of UK economic growth on multiple fronts.  

Slack slowly building in the UK labour market

As we mention, this data was nuanced. It also showed that there is some slack in the economy, and that growth could be slowing down. The number of vacancies in the UK between March and May decreased by 12,000 for the quarter to 904,000. This is still an elevated level and is higher than pre-pandemic levels, which could keep upward pressure on wage growth for the long term.

Inflation could keep the pressure on wage growth

Wages rose by a 5.9% annual rate with bonuses, and a 6% annual rate without bonuses. Real wage growth, wages adjusted for inflation, are also rising as inflation starts to fall. Real wages with bonuses are 2.2%, without bonuses real wage growth expanded by 2.3%. Both rates are above the BOE’s 2% target rate, but not by much. So, why can’t real wage growth be used as a justification for a rate cut? The BOE is expecting inflation to be bumpy over the coming months, so real wages could fluctuate quite wildly, and fall from here. This could keep upward pressure on wage growth in the coming months, as workers demand more compensation for the higher cost of living, thus real wage growth is unlikely to sway the BOE to cut rates this summer.

UK market reaction

The market has reacted to the employment data and seems to be focusing on the rise in the unemployment rate. Gilt yields have fallen by nearly 5 basis points at the open to 4.36%. GBPUSD has also fallen by 20 points to $1.2720. The FTSE 100 is set to open higher, after Monay’s drubbing on the back of the shock French election news. This data has also increased the prospect of an August rate cut. The market is now pricing in the chance of an August cut with a 40% probability, however, there is still only one cut fully priced in for the UK this year. We think an August rate cut is still unlikely, however, the movement in interest rate expectations could keep the pound under pressure on Tuesday.  

Europe recovers, but French banks remain under pressure

The focus this morning will also be on Europe. European markets were knocked at the start of the week on the back of the snap French Parliamentary election that will take place over two rounds in June and July. The euro is making a comeback this morning, after selling off sharply on Monday. EUR/USD is attempting to make a comeback, and is trading above 1.2760, although it is still below $1.08, the previous long-term support level that is now critical resistance. French 2-year yields are at their highest level since January, and the spread between French and German yields has continued to widen, as French bond yields outpace German bond yields. It seems that French bonds are a casualty of the French political turmoil, and they could remain under pressure for the duration of this election cycle.

French banks remain under pressure

European stocks are a sea of green on Tuesday as the market recovers after the initial shock of the French election. However, French banks are continuing to decline, albeit at a slower pace than Monday, and French exporters – Renault, L’Oreal, Sanofi, Kerring and Hermes are the top performers, since these companies are less domestically focused and are less likely to be impacted by the political turmoil in France. We will look at the prospects for French banks in more detail in a later note, however, the weakness of French bonds, which could persist until we know the outcome of this election, may weigh on the banking sector for the medium term.