Key Takeaways
- UK wage inflation is too high to be consistent with the Bank of England’s 2% inflation target.
- We expect the data to improve significantly over the next six months.
- Month-on-month numbers have shown a big slowdown and unemployment is ticking up.
- Labour market pressures are easing. Non-UK workers are coming back and others who left the workforce during the pandemic are returning too.
- Inflation is also trending down, and this will reduce pressure on wage growth.
- We believe that markets will begin to price in rate cuts early in 2024 with the first reductions at some point in the spring. The Federal Reserve will likely be first to move with the Bank of England at some point later in 2024.
Last week, we discussed the outlook for US interest rates and drew attention to the rapid decline in wage inflation there. It set the scene for big cuts in interest rates in 2024 in my view. This week, I look at the UK where the situation is very different.
UK wage growth far too high... but set to fall
Source: Columbia Threadneedle Investments and Bloomberg as at 20 October 2023
The chart shows the main measure of UK wage inflation. And it’s running hot, much higher than in the US and way too high to be consistent with the Bank of England’s 2% target. That’s the bad news. The good news is that wage inflation here is set to tumble over the next six months. First, there are already signs of a slowdown in the data. The year-on-year rate may be rapid but there’s been a big slowdown in the recent month-on-month figures and survey data show that wage pressures have subsided significantly. In addition, unemployment is on the increase. A major factor in the easing of labour market pressures has been immigration, the return on non-UK workers who left during the covid pandemic and the return to work of others who left the labour force then too.
Finally, inflation has fallen from the heady levels seen in the spring and late last year. That set the scene for really rapid wage growth in the last wage round. In the next round, headline inflation will be lower and unemployment higher. So a rapid fall in wage inflation is on the cards. The question is whether it will allow the Bank of England to begin cutting rates. The current level of wage inflation is 7.4% and it needs to be 3% or so to be consistent with the Bank’s target. That’s a long way off. However, if as seems likely, unemployment continues to edge higher, a clear downward trend in wage inflation should be enough for the Bank to cut base rates ahead of wage inflation falling all the way to 3%.
One slight wrinkle is that we can expect some stronger data over the next few months. Retail sales have been depressed by the unseasonably warm weather in September and early this month. They should bounce back as the winter gets underway. In addition, real incomes are getting a big boost from falling inflation and the increase in social security payments. Energy bills are still high but are falling.
So, I reckon that we will see big cuts in interest rates form the Bank of England in 2024. Timing is tricky, but the market should begin to price in cuts early in 2024 and I think the first move will come in the spring.
Compared with the US, the starting point is much worse in that both wage and price inflation are much higher here than in the States. But our labour market is clearly weakening. So, I think the US will cut first with the UK later in the year. Over in Europe it’s a different story: unemployment is exceptionally low, but the economy looks very weak. It is tough to call but the European Central Bank will surely join the rate cutting party in the first half of 2024 too.
