Has UK wage inflation peaked yet?

October 14, 2015

?????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????????Wage inflation is supposed to pick up once unemployment gets down to a level at which scarcity of labour means companies are forced to pay more for top talent. This time, at least so far, the theory is either not working so well, or taking its time to kick in. Or perhaps the modest rise we’ve seen is the best we’re going to get.

And it’s a global problem.

After a brief surge higher, average pay growth in Britain slowed unexpectedly even as the unemployment rate plumbed a new low, 5.4 percent, for this economic cycle. Only two economists in a sample of 34 even expected a slowdown in pay growth, and not a single one expected 2.8 percent.

UK average earnings

Pay growth excluding public sector and bonus pay has actually slowed to 1.8 percent over the past 3 months annualised, down from 4.5 percent, notes George Buckley, chief UK economist at Deutsche Bank.

This will matter immensely for the timing of the first Bank of England interest rate rise from a record low because, for all of the guidance we have received from Mark Carney and other Monetary Policy Committee members on what incoming data they are most closely watching, wage inflation is the most commonly cited. The U.S. Federal Reserve, which held off raising rates again just last month, appears to be doing the same.

There is very little else save for a sudden surge in global commodity prices that seems likely to get UK inflation back up toward the 2 percent target. It unexpectedly slipped back to -0.1 percent in September, matching a low earlier this year that hadn’t been recorded since 1960. 

That’s not all bad of course. The wide gap between no inflation and the modest wage inflation reported is what is going into people’s pockets. And that, according to theory, is money gets spent in the real economy which spurs on the economic expansion which then feeds into wages. The last time the gap was this positive and this wide was in 2007, just before the financial crisis.

UK wages growth, GDP and inflation


Much of the discrepancy stems from the nature of work being created. Of the impressive 140,000 surge in employment, half of the jobs created were part-time and self-employment. Those categories tend not to lend themselves to strong pay gains – the evidence on self-employment shows the opposite. They may be happier with flexible work hours, but most people do not end up making as much money working for themselves.

So while there clearly are signs of recruitment difficulties in some industries, the trouble isn’t widespread enough to be pressuring wages a lot higher.

“Excluding bonuses, wage growth broke from what had seemed like an inexorable upward trend in recent months. Private sector regular pay (which is scrutinised closely by the MPC) slipped back to 3.2 percent from 3.3 percent. However we would note that this measure is still a full two percentage points higher than it was twelve months ago,” said Investec economist Philip Shaw.

There is also evidence just published this week from the Resolution Foundation that suggests much of the recent pay gains are being reaped by older experienced workers, at a managerial level, who are more highly-paid anyway. Those figures may be nudging up the average when they’re big enough, but clearly that won’t be enough to boost overall inflation in the economy unless it’s shared more widely, especially among those who earn the least.

Morgan Stanley last month predicted that pay growth will plateau below 4 percent, ruling out the likelihood of any further sustained acceleration. That is looking so far like a very good call. They, like many central bankers have done recently, pointed to a weak global backdrop as cautionary. And with another round of cuts to the public sector ahead, there isn’t much evidence that points to employees having won back the upper hand over their employers. 

Other indicators that are a good marker for British pay growth have cooled over the last year.

Growth in starting salaries for permanent staff hit a 20-month low in September, according to the latest REC survey. The British Chambers of Commerce’s pay settlements index for services companies has fallen in each quarter so far this year. The Bank of England Agents survey index of services labour costs has been stuck at the same level for 13 months. And a survey of employers from ExpertHR has shown no sign employers are going to budge from handing out annual pay awards of 2 percent.

Indeed, weak pay growth — or at least weaker than what one would expect for this very mature stage of the economic cycle, particularly in Britain and the U.S. — appears to be a global economic force.

With inflation in China plummeting to 1.6 percent – well below even the modest inflation target of most western central banks – and the IMF and other prominent economists worrying about a relapse to anaemic global growth, it may be prudent not to expect much more in the way of pay gains. 

Additional reporting by Andy Bruce

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