Will slowing UK wage growth lead to early rate cuts?

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Clear evidence of a slowdown in UK wage growth is one of the crucial changes that Bank of England policymakers want to see before they can conclude that inflation is sustainably on the way down and start cutting interest rates.

Tuesday’s official data, showing a sharp decline in the pace of earnings growth in the three months to November, raised hopes among some economists that pay pressures had already eased enough for inflation to fall below the BoE’s 2 per cent target within months.

Such a decline could pave the way for a loosening of monetary policy, with investors betting that the BoE will starting lowering its benchmark rate from a 15-year high of 5.25 per cent from May.

But others said the true state of the labour market was still clouded in uncertainty, while the Office for National Statistics continued to grapple with problems that have prevented it publishing many of the figures on which policymakers usually rely.

On the face of it, the data suggests the central bank now stands a much better chance of steering the economy into the kind of “soft landing” it would like to achieve: cooling the labour market and returning inflation, which stood at 3.9 per cent in November, to target without a painful jump in unemployment.

The ONS said vacancies, while still above pre-Covid levels, fell for the 19th month in succession in December, while the number of payrolled employees remained broadly stable.

Annual growth in earnings — both including and excluding bonuses — remains high by historic standards, at 6.5 per cent and 6.6 per cent, respectively. But it is well below the peaks reached in the summer of 2023. Monthly figures, while volatile, show average earnings in the private sector have barely risen since August.

“This means that annual pay growth will continue to fall in early 2024 — and is no longer fuelling inflation,” said Hannah Slaughter, senior economist at the Resolution Foundation think-tank.

Jack Meaning, economist at Barclays, said private sector wage growth was now below the rate consistent with keeping inflation on target at 2 per cent. This suggested that the BoE had “baked in too much caution” when it published forecasts in November that estimated private sector wage growth of 7.25 per cent for the final quarter of 2023, he added.

But Chris Hare, senior economist at HSBC, said a “cloud of uncertainty” around labour market data made it hard to assess the extent of any slowdown in wage growth, or to tell what was driving it.

The big issue is the ONS’s continued inability to publish its usual estimates of employment, unemployment and economic inactivity while it contends with a drop in the response rate to its labour market survey and reweights the results to take account of new population estimates.

The agency, which last released full figures in September, had been due to resume publication this week. But it has delayed for another month to perform further checks for quality.

In the meantime, it is publishing stop-gap estimates based on tax and benefits records. On Tuesday, these suggested unemployment had remained steady at 4.2 per cent since last summer — below the 4.5 per cent level the BoE now thinks is consistent with inflation remaining sustainably at target.

But business surveys and recent trading updates from big recruitment companies suggest the jobs market may have softened more than this. Hays, Robert Walters and PageGroup have all reported weaker hiring conditions in the past week.

James Smith, economist at ING bank, said that “part of the issue for policymakers is that we still don’t have a true grip on what’s happening to unemployment”. He added that the Monetary Policy Committee would want to see “more progress” on wages in both official data and alternative surveys “before kick starting an easing cycle”.

The central bank has called attention to discrepancies between the official earnings figures and other survey-based measures of wage growth, which mean it is not placing too much weight on any single data source.

Michael Saunders, a former MPC member now at the consultancy Oxford Economics, said the ONS data, recent company pay awards, and survey evidence all suggested pay growth was still too high for inflation to return sustainably to 2 per cent.

“Lower inflation and rising unemployment may reduce pay growth further . . . but it’s far from guaranteed,” he said.

Economists said there were other reasons why the BoE might want to wait until early summer before cutting interest rates.

By then, it should have a clearer view of unemployment. It will also want to see how April’s planned uprating of the minimum wage, the state pension and working-age benefits affects overall pay growth and feeds through to consumer spending. It will also be able to assess the likely impact of any tax cuts announced in the Budget on March 6.

“The MPC will need to see pay growth subside further before it seriously contemplates bringing interest rates down,” said Philip Shaw, economist at Investec.

Saunders said that even if inflation fell rapidly in the near term, “the MPC’s focus will be mainly on whether conditions for a sustained return to 2 per cent inflation are in place”.

“On this score, the evidence looks less reassuring,” he added.