How wage inflation has been tamed

News Analysis: Two factors - the New Deal work scheme and low price rises - have helped to draw the sting from pay expectations

EIGHT MONTHS ago the Bank of England was so concerned about inflationary pressures in the labour market that it hiked UK interest rates up to 7.5 per cent. Unemployment was unsustainably low, the Bank said, and would have to rise in order to keep inflation in check.

Since that shock rate rise last June, unemployment has fallen further and employment has risen. Official figures out tomorrow are expected to show unemployment staying close to 20-year lows. Despite this, the Bank felt comfortable cutting interest rates half a point to 5.5 per cent this month and leaving the door open for further cuts in last week's quarterly inflation report. So why isn't the Bank worried about wage inflation any more?

Part of the answer is that deflationary pressures from other sources - falling factory gate and commodity prices - have outweighed concerns about inflationary pressures in the labour market. Another is that some information the Bank based its decision on in June - the official average earnings index - turned out to be questionable. In particular, the worryingly sharp rise in earnings in the first half of the year was revised away in the autumn when the Office for National Statistics issued new numbers.

A third reason for the Bank's apparent lack of concern about developments in the labour market is that unemployment is a so-called "lagging" indicator - it takes time for a drop in growth to impact on jobs. So, although the backward-looking official data may still be painting an upbeat picture, things may not stay rosy in coming months.

Indeed, all the forward-looking studies of employment intentions - such as the British Chambers of Commerce survey - suggest that unemployment will rise in the next 12 months. "The fact that we haven't seen an increase in unemployment so far shouldn't make people too sanguine," said John Philpott, director of the Employment Policy Institute. And, although official earnings data have been suspended in the wake of the confusion over the revisions, surveys suggest that wage inflation may be moderating as employers tighten belts and prepare for tough times ahead. Analysts at Goldman Sachs say: "On the partial information available, there appears to have been a stabilisation in pay deals in 1999 at around the 4 per cent level recorded last year."

A growing body of economists, however, believe there is a fourth, perhaps more significant, reason for the dwindling concerns about developments in the labour market. In recent months there have been tentative signs of fundamental changes in the jobs market that may mean the UK is less prone to periods of high wage inflation and high unemployment than it has been.

In particular, there has been evidence both of the positive impact of the Government's New Deal and of a change in expectations about future inflation - a key determinant of wage increases.

Take the New Deal first. Although it is early days for the government's scheme, the initial signs are encouraging. The Employment Policy Institute's regular survey of employment trends - the latest issue of which is published tomorrow - finds that unemployment has "undoubtedly been affected by various government initiatives". Dr Philpott noted that the number of long-term unemployed in the 18 to 21 age group - a group specifically targeted by the New Deal - fell by 25 per cent between January and October last year. Data on inactivity is also encouraging. There has been a steady decline in the rate of inactivity - that is, the proportion of people who do not want a job.

Although it is difficult to disentangle the impact of government initiatives on the labour markets from other factors, most experts seem agreed that initial indications are good. According to Dr Philpott, government initiatives should "increase the effectiveness" of the UK's labour pool. He said: "That means there is less likelihood of inflationary pressures in the labour market. Assuming government policy continues to move in the right direction, we should see the sustainable rate of unemployment fall."

Falling inflation expectations also indicate that there may have been structural shifts in the UK labour market. Expectations about low inflation tomorrow tend to mean lower levels of wage inflation today. Employees are more likely to accept low wage increases if they believe the cost of living has stabilised.

So why have inflation expectations fallen? This is in large part due to the decision to grant the Bank of England independence. People have doubts about the ability of politicians to stick to tight inflation targets, but the independent Monetary Policy Committee has established itself in most people's minds as being a tough inflation fighter. Another factor may be the growing belief that the UK will join European monetary union - Europe's inflation track record has been better.

Looking ahead, however, things may become a little more difficult. British business, quite understandably, is concerned about the administrative burden of new measures such as the Working Families Tax Credit and the European Working Time Directive. There are also worries that the National Minimum Wage - although perhaps desirable on social grounds - may undermine labour market flexibility. So far, government reforms, both of incentives to work and in monetary policy, do seem to have had a positive impact in the jobs market. The challenge now is to keep the momentum going.

Start your day with The Independent, sign up for daily news emails
Voices
There will be a chance to bid for a rare example of the SAS Diary, collated by a former member of the regiment in the aftermath of World War II but only published – in a limited run of just 5,000 – in 2011
charity appealTime is running out to secure your favourite lot as our auction closes at 2pm today
News
File: James Woods attends the 52nd New York Film Festival at Walter Reade Theater on September 27, 2014
peopleActor was tweeting in wake of NYPD police shooting
Sport
Martin Skrtel heads in the dramatic equaliser
SPORTLiverpool vs Arsenal match report: Bandaged Martin Skrtel heads home in the 97th-minute
News
Billie Whitelaw was best known for her close collaboration with playwright Samuel Beckett, here performing in a Beckett Trilogy at The Riverside Studios, Hammersmith
people'Omen' star was best known for stage work with Samuel Beckett
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Carlton Senior Appointments: Private Banking Manager - Intl Bank - Los Angeles

$200 - $350 per annum: Carlton Senior Appointments: Managing Producer – Office...

Carlton Senior Appointments: San Fran - Investment Advisor – Ind Advisory Firm

$125 - $225 per annum: Carlton Senior Appointments: San Fran - Investment Advi...

Sheridan Maine: Commercial Finance Manager

Up to £70,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Sheridan Maine: Regulatory Reporting Accountant

Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Day In a Page

Surrounded by high-rise flats is a little house filled with Lebanon’s history - clocks, rifles, frogmen’s uniforms and colonial helmets

Clocks, rifles, swords, frogmen’s uniforms

Surrounded by high-rise flats is a little house filled with Lebanon’s history
Return to Gaza: Four months on, the wounds left by Israel's bombardment have not yet healed

Four months after the bombardment, Gaza’s wounds are yet to heal

Kim Sengupta is reunited with a man whose plight mirrors the suffering of the Palestinian people
Gastric surgery: Is it really the answer to the UK's obesity epidemic?

Is gastric surgery really the answer to the UK's obesity epidemic?

Critics argue that it’s crazy to operate on healthy people just to stop them eating
Homeless Veterans appeal: Christmas charity auction Part 2 - now LIVE

Homeless Veterans appeal: Christmas charity auction

Bid on original art, or trips of a lifetime to Africa or the 'Corrie' set, and help Homeless Veterans
Pantomime rings the changes to welcome autistic theatre-goers

Autism-friendly theatre

Pantomime leads the pack in quest to welcome all
The week Hollywood got scared and had to grow up a bit

The week Hollywood got scared and had to grow up a bit

Sony suffered a chorus of disapproval after it withdrew 'The Interview', but it's not too late for it to take a stand, says Joan Smith
From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?

Panto dames: before and after

From Widow Twankey to Mother Goose, how do the men who play panto dames get themselves ready for the performance of a lifetime?
Thirties murder mystery novel is surprise runaway Christmas hit

Thirties murder mystery novel is surprise runaway Christmas hit

Booksellers say readers are turning away from dark modern thrillers and back to the golden age of crime writing
Anne-Marie Huby: 'Charities deserve the best,' says founder of JustGiving

Anne-Marie Huby: 'Charities deserve the best'

Ten million of us have used the JustGiving website to donate to good causes. Its co-founder says that being dynamic is as important as being kind
The botanist who hunts for giant trees at Kew Gardens

The man who hunts giants

A Kew Gardens botanist has found 25 new large tree species - and he's sure there are more out there
The 12 ways of Christmas: Spare a thought for those who will be working to keep others safe during the festive season

The 12 ways of Christmas

We speak to a dozen people who will be working to keep others safe, happy and healthy over the holidays
Birdwatching men have a lot in common with their feathered friends, new study shows

The male exhibits strange behaviour

A new study shows that birdwatching men have a lot in common with their feathered friends...
Diaries of Evelyn Waugh, Virginia Woolf and Noël Coward reveal how they coped with the December blues

Famous diaries: Christmas week in history

Noël Coward parties into the night, Alan Clark bemoans the cost of servants, Evelyn Waugh ponders his drinking…
From noble to narky, the fall of the open letter

From noble to narky, the fall of the open letter

The great tradition of St Paul and Zola reached its nadir with a hungry worker's rant to Russell Brand, says DJ Taylor
A Christmas ghost story by Alison Moore: A prodigal daughter has a breakthrough

A Christmas ghost story by Alison Moore

The story was published earlier this month in 'Poor Souls' Light: Seven Curious Tales'