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Forex: Economics Weekly - Continued labour market strength key to UK economic growth in 2005

Economics Weekly
Economic Research and Analysis

Continued labour market strength key to UK economic growth in 2005

UK employment is key to economic growth
Economic growth has slowed in the UK, led by consumer spending and by a slump in manufacturing output. With attention focused on activity data, given rising concern over economic growth prospects, a further 1.6% decline in manufacturing output in March was particularly worrying. In addition, fears of a continuing slump in high street sales were fuelled by a set of dismal surveys in April and a series of poor corporate earnings reports. However, official April retail sales data surprised the financial markets by showing a 0.5% rise in volumes, although this still saw the annual rate fall to 2.3%, the weakest in two years. What are economic prospects in the months ahead, particularly for consumer demand which is two-thirds
of the expenditure measure of the economy? One of the key guides to future spending is growth in incomes, which in turn is related to wage increases and growth in employment. In this weekly, we concentrate on employment trends.

Economic growth fast enough to create jobs
When the economy is growing faster than its average rate, or faster than growth of the labour force, then unemployment should fall and employment should rise. Chart A shows that growth in employment and the economic cycle are indeed very closely linked. When economic growth averages around 2.3% a year, employment will rise, and, as chart B shows, unemployment will fall. But labour market data showed a third consecutive monthly rise in the claimant count in April. Should we therefore be worried about economic growth because of the recent rise in claimant count unemployment which might lead to even slower growth in consumer spending?

But unemployment rises...
The number of people claiming benefits rose by 8,100 after a 13,600 gain in March, but the unemployment rate remained at 2.7%. However, on the International Labour Force (ILO) measure - preferred for international comparison as it is a measure of those seeking work rather than being eligible to claim benefits the unemployment rate declined to 4.7% in the three months to March from 4.8% in the previous quarter. The number of unemployed fell by 15,000 and those in employment rose by 87,000. The UK labour market remains clearly tight and record employment and low unemployment should underpin economic growth in 2005.

...so should we worry?
This is supported by the fact that despite the slower pace of economic growth in the first quarter of 2005, employment is currently rising. This gives an important signal that activity in the UK is still robust overall. It should be noted that even though economic growth slowed, the annual rate remained at 2.7% in Q1, well above the level required to generate growth in employment as implied by chart A. But we also know that manufacturing is in recession so where are the jobs being created and is that growth in employment sustainable? Charts C and D show that the jobs are coming from the public sector, construction and private services. Jobs are still being lost in manufacturing, but some of those may be being relocated to other sectors as the industry becomes more efficient and focused on design and technology. Moreover, economic data showed that construction activity in Q1 2005 was 3.1% higher than in the same period of 2004 and was up by 3.7% in the services sector. This would support continued jobs growth as economic growth is in the very sectors where employment is expanding.

Employment and growth looks robust
In addition, latest surveys of activity in the construction and private services dovetail with the evidence from the employment data. The services PMI was 56.5 in April and in construction it was 54.5, well above the key 50 level and signaling growth of 3 to 4% at an annual rate. Intentions to employ in these surveys also remain solidly above the key 50 level, indicating positive growth. There may be more of a question mark about the jobs being created in the public sector, but though public finances are stretched they are no where near crisis levels, so the jobs that are being created in education and health (the majority) do seem secure. Overall, based on the labour market trends, economic growth should remain positive enough to suggest that, alongside continued growth in wage inflation, consumer spending ought to recover sometime in 2005. This may be dependent on consumer confidence and the housing market. But it is also worth noting that though consumer confidence has weakened, it remains above its long run average and stronger than implied by the rate of consumer spending. This bodes well for continued economic growth and a recovery in consumer spending later on in the year, as it suggests that confidence is being sustained by low unemployment and solid wage growth.

Economic indicators
UK economic data this week will put to the test whether consumer confidence and services and construction activity will be robust enough to offset weaker growth from the manufacturing sector. We look for signs of economic recovery.

Trevor Williams, Chief Economist
trevor.williams@lloydstsb.co.uk
www.lloydstsbfinancialmarkets.com
Lloyds TSB Bank,
Financial Markets
Division,
Faryners House,
25 Monument,
London EC3R 8BQ
Switchboard:
0207 283 - 1000

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