Is the cost of living crisis driving monetary policy or is the labour market?

Due to the various exceptional circumstances in the world of politics and economics over the past two years, the usual indicators of the economic outlook and monetary policy in the UK are much less clear cut than they normally would be:

In March 2022, GDP fell which was reported to be a consequence of the rising cost of living by the media. But it appears that the 15% month on month fall in the motor vehicle industry, (which triggered the decline), may have been an issue of supply due to lack of workforce rather than a lack of demand due to lack of affordability.

While many surveys point to a downturn in the economy, there is a lack of hard data to support this and, moreover, there is actual data to the contrary. One example being that the GfK consumer confidence index is at its lowest since 2008 yet restaurant custom is up by between 20-30% on 2019 levels.

The labour market is also not indicative of a downturn: the UK economy is generating jobs at a very fast pace and is short of workers. This can be more important than the GPD and survey data for monetary policy: the labour market paints a picture of the domestic inflation outlook – the aspect of inflation that can, in theory, be controlled by the Bank of England (in contrast with the aspects the BoE cannot control e.g. food and energy supply).

Michael Saunders, member of the Bank of England’s Monetary Policy Committee focussed on the labour market in his speech in support of a 50bps rate rise last week. Governor Andrew Bailey also referenced the labour market when he testified to the Treasury Select Committee. Both have pointed to the fall in workforce supply through lower participation and both have mentioned long term health issues due to Long Covid or NHS waiting lists as a key issue in this regard and the latest data appears to back this up.

The Monetary Policy Committee clearly want to do less tightening, but they will be looking for some improvement to the imbalances in the labour market before they have the confidence to pause. This could become more evident by August and more hard data on if the cost of living crisis is slowing down the economy could also become apparent and influence the next stages of inflation.