Will Wage Inflation Become a Concern for the UK in 2023?

Given the industrial unrest in the United Kingdom at the moment, where do you see wage inflation going over the next few months?

Yesterday, ambulance staff across three unions exercised their right to strike in the latest round of industrial action to affect the nation. The most recent estimates from the Office of National Statistics (ONS) indicate that in November 2022, 467,000 working days were lost to labour disputes – the highest we have seen in eleven years. Though this figure remains far below the figure of nearly 3 million lost working days in January 1979, there are signs that industrial pressure will give way to public sector pay rises; recently, talks of ‘one-off’ payments to workers and ministers’ returns to negotiations after the Christmas holidays have certainly hinted so.  While its therefore plausible that industrial action will contribute to wage inflation over the coming months, I’d argue that it won’t be the full story.

Our latest wage tracker noted that the annual growth rate of average weekly earnings, excluding bonuses, was 6.4 per cent in the three months to November – representing the largest growth in regular pay in the UK outside of the pandemic period. Growth in total average weekly earnings (i.e including bonuses) was also 6.4 per cent. This economy-wide growth rate comes from multiplying wage growth in the private and public sectors by representative weights (82 and 18 per cent, respectively).  When broken down by sector, average growth in total pay for workers in the private sector in the three months to November was 7.1 per cent while for workers in the public sector it was 3.3 per cent. Through this break-down, we can also see that wage growth in the public sector has been steeper since summer, around the time that government accepted many wage review recommendations by Pay Review Bodies (PRBs), alongside the first waves of industrial action.

Workers in different sectors have seen asymmetric hits to their real income, as private sector earnings growth has overtaken that of the public sector and both have been outpaced by inflation. It is important to bear this in mind in any discussion of wage inflation in the UK. It is equally important to understand that the effects of this erosion of living standards will remain with us for years: the OBR’s November forecast expects real household disposable income to drop nearly to 2013-2014 levels in 2024-2025, declaring a decade of lost growth.

Looking towards the future, our latest wage tracker implies a growth in total average weekly earnings of 6.4 per cent both for the last quarter of 2022 and for the first quarter of 2023, broadly consistent with expectations noted in the Bank of England’s Decision Maker’s Panel. For the private sector, this translates to growth rates of 7.0 and 6.9 per cent for 2022 Q4 and 2023 Q1, respectively; for the public sector, 3.9 and 4.6 per cent, respectively.  So, we expect to see wage inflation maintaining significant growth over the next few months: we forecast this will result from rising public sector earnings growth that will counteract the marginal drop in its private sector counterpart. Overall, however, the figure of 6.4 per cent wage growth over these quarters (or whatever the data outturn will end up being – we’ll know by May) will be driven by the private sector, which we estimate will see earnings growth fluctuate on average around 7 per cent until March.

What role do you think the Pay Review Bodies might have in affecting this?              
As explained in further detail in last weeks’ Monday interview, the purpose of PRBs is to advise the government about appropriate pay awards for around 2.5 million public sector workers given external conditions (like cost of living changes) and internal conditions (like the recruitment and retention environment within a particular labour market). The PRB recommendations for the 2022/2023 financial year were based on data from late 2021/early 2022 – when the CPI inflation rate was around 4 per cent – but were largely accepted by government departments in July, at which point the inflation rate had already risen to 10.1 per cent. Consequently, many public sector workers have seen their real incomes eroded this year, despite pay increases. Our wage tracker estimates that public sector workers experienced a fall in real total pay of 5.4 per cent in the three months to November, compared to a whole economy fall of 2.6 per cent.

According to the Office of Manpower Economics – the government office within the Department for Business, Energy and Industrial Strategy which works with the PRBs –   the timetables for the majority of PRBs run from October to February. In other words, the PRB recommendations for the 2023/2024 financial year can be expected to be based on data from late 2022/early 2023, delivered to government by February, and accepted (or rejected) sometime in the following months. Given that the average rate of inflation in the fourth quarter of 2022 was 10.8 per cent and that inflation rates will be decreasing over the coming year (more on this below), it is possible that PRBs will recommend high pay increases that will be above the rate of inflation at the time of implementation (though whether such compensation would be sufficient to counteract the current fall in living standards is uncertain). Given the lagged nature of this pay process, it is therefore likely that this year, PRBs may contribute to increasing wage inflation despite their historical role in controlling it. That said, it is up to government departments to accept the PRB recommendations (though under the present inertia in favour of industrial unrest, the balance seems to be tipped towards accepting).

Where do you see CPI inflation going over the coming months and how is this likely to be affected by what’s going on in the labour market?

Data on Consumer Price Index (CPI) inflation is calculated at a higher frequency than wage data. The ONS’s latest estimates suggest that headline CPI inflation fell to 10.5 per cent in December from 10.7 per cent in November, driven by price decreases in motor fuels, and clothing and footwear, partially offset by large price increases in food. Though this marked a consecutive month of falling CPI inflation, there are multiple signs that inflationary pressures have not yet cooled in the UK. As shown in our recent CPI Tracker, different measures of ‘core’ or underlying inflation in December, such as CPI excluding food, alcoholic beverages and tobacco, as well as trimmed-mean CPI inflation remain elevated. Plainly speaking, this means that it is likely that inflation is more persistent and broad-based than previously thought; it is no longer the case that inflation is solely a result of post-pandemic supply chain disruptions or the Russian invasion of Ukraine, but rather, it has permeated to other areas of the economy including the labour market.

So, while annual inflation rates will fall through 2023 (given that they are calculated relative to the previous year, this will be the case so long as we don’t observe price increases in 2023 that overtake those observed in 2022), it is possible that increasing wage inflation will contribute to maintaining persistence in inflation such that it will slow the fall in price rises. Worryingly, it will also heighten the risk of elevated inflation rates embedding themselves in expectations. We expect this is something the Bank of England will address at its upcoming meeting on 2 February.