The new Godot: waiting for wage inflation

September 7, 2015

Actors Maertens and Stoetzner perform on stage at Vienna's BurgtheaterBoth of the two top central banks considering an interest rate rise from near-zero are hoping for a significant pickup in wage inflation and have been waiting a long time for it to turn up.

Based on speeches and public remarks over a long period of time, it is clear both Federal Reserve chief Janet Yellen and the Bank of England’s Mark Carney are more likely to react to decisive moves up in pay than a whole bunch of other developments.

After many years of zero rates and trillions of dollars of cash put into the financial system through government bond purchases, however, central bankers are still scrounging to find evidence of extra cash in regular people’s pockets.

While average earnings growth has picked up somewhat in the UK this year and is outstripping a lowered Bank of England forecast for 2015, there is still no evidence that points in any definitive way that workers have regained the upper hand on employers.

Set aside for one moment the obvious challenge policymakers have in justifying taking away extra money the average worker may have managed to secure by hitting them with higher borrowing costs – especially after many years during which the cost of living, even with inflation so low, has outpaced money coming in for most families.

Employment growth appears to have slowed in both the U.S. and UK economies in recent months after a torrid pace of hiring that has brought down the jobless rate to levels normally associated with a lot more wage inflation and much higher interest rates – certainly not zero.

Private survey evidence also suggests a hiring slowdown, as evidenced in the latest Recruitment and Employment Confederation/KPMG report.

Of course, a hiring slowdown need not mean that wage inflation is about to take a turn for the worse or even that the expansion will soon end. At this stage of a normal business cycle, such a tight labour market would be causing skill shortages and pushing up on wage settlements even with hiring slowing.

The trouble is, the news on that has been slim and mostly anecdotal. Even the REC/KPMG survey, which tracks pay settlements, points to a cooling off in rises in pay agreed when companies take on new staff. That in and of itself is measuring a small portion of people in the economy, especially when you consider that job market turnover is not back to the rate it used to be before the financial crisis struck more than seven years ago.

Indeed, the evidence is that people are holding on to positions longer, and accepting less generous pay rises each year in exchange for some job security.

REC chief executive Kevin Green said in the latest report:

“The UK jobs market is entering a new phase. Because of the scarcity of talent available, we expect that employment will continue to grow but at a slower speed than we have seen over the past two years. Likewise, unemployment is likely to slow its rate of descent as we move closer to full employment. In response to worsening skills shortages, employers are focussing on retaining the staff they have and this will promote wage growth.”

The active words there are “will promote.”

The REC monitor of pay has been a pretty good directional guide for official pay growth over recent years. If the latest figures are worth relying on, they might even be suggesting a leveling off as they re-claimed the heights before the financial crisis and have struggled to go any higher. 

Either way, it seems unlikely there will soon be a sharp spike higher in UK pay growth – at least not without a burst in broader economic growth that comes from something other than average people spending more money. With a fiscal austerity programme in full swing, global trade slowing and financial markets jittery, it’s tough to see where that will come from.

The latest labour market outlook from the Chartered Institute of Personnel and Development, based on a survey of nearly 1,000 UK companies, showed only 16 percent of employers said they had raised compensation to respond to difficulties in recruiting hard-to-fill positions. The same report also found that 57 percent of private sector firms said that cost management was their top priority.

The latest data from the U.S. don’t look much different. Wage inflation ticked up a bit higher than expected in August, but not at a pace that would suggest a step-change is afoot, however much economic theory based on business cycles before the financial crisis would have you believe.

Jan Hatzius, chief U.S. economist at Goldman Sachs, wrote:

“Although growth has been decent and the labor market has improved further, both wage and price inflation have fallen short of consensus expectations. Our wage tracker stands at just 2.1% as the Q2 employment cost index surprised on the downside, and core PCE inflation just made a four-year low of 1.24%.”

The pay growth may eventually come quickly, and many, including Yellen and Carney, may be taken off guard by it. But so far the ones who have had to do the explaining are those sticking to economic theory that states that this far down the line in the expansion, both wage growth and interest rates should be much higher.

They aren’t and they won’t be – at least not for a while yet. 

With additional reporting by Andy Bruce

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