In its February 2014 Inflation Report the Bank of England’s Monetary Policy Committee argued that the outlook was “for only modest rises in wages”. The Bank’s chief economist at the time, but now mercifully departed, Spencer Dale, who was in charge of the forecast, explained that “we expect real earnings to go positive, hopefully sometime in the second half of this year”. But in its May 2014 Inflation Report the MPC had become even more optimistic, arguing that their central view “implies that whole-economy annual total pay growth should approach 2.5 per cent by the end of 2014”.
Based on their forecast for Consumer Price Index inflation of around 1.9 per cent, this implied real wage growth, but less clearly so if the Retail Price Index was used. This change was apparently driven by the unemployment rate falling between these two meetings to 6.9 per cent from 7.1 per cent over the three-month period. Wages were expected to rise as the economy approached full-employment, which the Bank’s staff estimated was in the range 6-6.5 per cent.
Sadly it didn’t exactly work out like that as wage growth has fallen in each of the last three months. The chart below makes clear what has happened to wages: very little. There was a sharp drop in wages in March 2013 as workers deferred bonuses to the next financial year, hence the big upward bump in April 2013. Since then wages have been remarkably flat: the last 12 readings included three £475s, three £476s, four £478s, one £479 and one £477, which is the latest reading. If you take the single month number of £477 for June 2014 and compare it with the number a year ago in July 2013 of £475, you get growth of 0.4 per cent. But if you take the three-month average and compare it with the average a year earlier, nominal wages fell by 0.2 per cent.
Evidence from Incomes Data Services last week on wage settlements, which tend to relate to workers with the most bargaining power, suggested the median pay settlement was around 2.5 per cent. This estimate was based on 107 settlements in the three months to the end of March 2014, covering 224,887 employees.
Ken Mulkearn, Head of Pay and Research at IDS, said: “As we move into the prime period for annual pay reviews, settlement levels are mostly stable. The main factor in the comparison with the cost of living is the fall in inflation, rather than any rapid acceleration in pay growth.” The last time the median pay award was ahead of inflation was in the three months to November 2009, when the median settlement recorded by IDS was 1.5 per cent and RPI was just 0.3 per cent.
The MPC’s forecasts on what would happen to wage growth have been poor once again. They refused to listen to commentators like my friends David Bell from the University of Stirling and Steve Machin from University College London and the Centre for Economic Performance and myself, who told them there was much more slack in the labour market than they thought and real wages weren’t set to rise any time soon. But they wouldn’t listen and now look at the fine mess they have gotten themselves into.
In the MPC’s August Inflation Report, out last week, despite the fact it cut its estimate of the extent of slack to 1 per cent, it admitted wage growth is “likely to remain weak for the remainder of 2014”. The Inflation Report went on to admit also, that “the level of average weekly earnings (AWE) is expected to be little different in Q2 than in the same period a year earlier, in both the whole economy and private sector” and that one of their key judgments was “four-quarter AWE growth approaching 1.5 per cent by the end of the year”.
Mark Carney in his opening statement even admitted “pay growth has been remarkably weak, even as unemployment has fallen rapidly.” It is puzzling though that the MPC should reduce their estimate of how much slack there is in the labour market and also lower their estimate of wage growth. They squared this circle by explaining they had also cut their estimate of the full-employment rate to between 5 per cent and 5.5 per cent, down around 0.75 per cent on where they anticipated in August 2013. I suspect it is a lot lower, perhaps around 4 per cent or so.
The Office for National Statistics has now calculated a long-time series back to 1963 on Average Weekly Earnings (AWE), which is the national statistic on earnings. The chart plots the data against the RPI. The latest recession is unprecedented in that this is the first time the RPI has gone negative in the last 50 years; it was negative in every month from March 2009 through to October 2009. If we calculate real wage growth by simply deducting the RPI, it is interesting to see how real wage growth and inflation are correlated. In the period from January 1964 to December 1969, the monthly RPI averaged 4.1 per cent while real wage growth averaged 2.9 per cent. The numbers subsequently are as follows with the average RPI in brackets; 1970s 3.0 per cent (12.7 per cent); 1980s 2.9 per cent (7.5 per cent); 1990s 1.5 per cent (3.7 per cent); 2000-2007 1.6 per cent (2.8 per cent); January 2008-April 2010 -0.1 per cent (2.1 per cent) and May 2010-June 2014 -2.2 per cent (3.8 per cent).
This shows how unprecedented the collapse in real wages is under the Coalition, and is even greater than in the period of the Great Recession from 2008 until the Coalition took office in May 2010. This is the only extended period in which the RPI is above the AWE in the last 50 years.
The MPC has made clear that, based on falling wage pressure, that the chances of a rate rise in 2014 have totally disintegrated and may not even happen in 2015, especially if the US Federal Reserve fails to raise rates. The eurozone is slowing again and six European countries including Switzerland, Portugal and Greece are experiencing deflation with the eurozone inflation rate at only 0.4 per cent.
Don’t listen to a word the inflation nutters say. Now is definitely not the time to raise rates. Actually a bit of inflation might be nice: in the past it has had a wonderful side effect it has been accompanied by real wage rises for workers.
Nice thought. I vote for some inflation.