Unemployment falls, but will pay packets rise?

The nature of being an economist is the ability to balance the results of the past with the news of the present – and using both to manage expectations of the future. We will see all of these in a microcosm in the coming week with the publication of both the latest jobs report from the UK economy and the minutes from December’s Bank of England meeting.

There are few announcements that are more economically and politically charged than the unemployment report. Remember, the Bank of England first chose an unemployment rate threshold as the trigger for interest rate rises as part of its ‘forward guidance’ plan. That plan lasted around six months before it was changed to focus on wages, amongst other measures of economic performance.

Wages are currently rising here in the UK in real terms i.e. at a faster rate than rises in inflation. This is a new development in the UK. Wages have only outpaced inflation in three months since June 2008 and even now, most of this positive motion is not coming from a substantial increase in wages but instead the recent large falls that we have seen in inflation.

As we highlighted in today’s Morning Update – available here – falls in a country’s unemployment rate are not guarantees of imminent wage growth. The theory goes that as more and more people gain jobs, businesses must increase wages in order to tempt the right talent into their workforce. As the unemployment rate dips, pressure on wages should increase. "Whether we've seen the inflection point for UK wages and whether they should run higher from here will be seen on Wednesday."

Of course, there is a natural lag. Businesses appearing bleary-eyed from a recession and starting to grow are unlikely to start bringing on new staff immediately. Firstly, they are more than likely to make existing staff work longer hours to make up for the lack of productivity and secondly, which shareholder wants to pay out a company’s profits in the form of wages unless it absolutely has to?

Whether we have seen the inflection point for UK wages and that they should run higher from here will be seen on Wednesday morning. The combination of slower price rises and rising wages is an obvious plus for the UK economy and consumers within it.

We expect that the Bank of England will mention both the cause and effect in the minutes from their December policy meeting. While we will have to wait until February’s Quarterly Inflation Report for the Bank’s latest projections of inflation, it provides an obvious crutch with which to lean on should you be of the view that rate rises can wait.

Back in December, David Miles – one of the MPC members currently voting for rate rises – told the Telegraph that it is possible that when his term expires in August, he will be the only member of the Bank of England to not have seen rates rise during his tenure. I still think that rates will rise here in the UK towards the back end of 2015 but the nature of inflation targeting is the main risk to this.

These minutes may allow us to see whether the majority of the Monetary Policy Committee is focused on the headline rate of inflation in the UK or whether it’s core prices that are guiding their expectations. As we have seen with other inflation announcements in recent weeks, it’s not so much about the headline index but more the ‘core’ reading in my opinion. The harmful effects of falling commodity and energy prices are obvious but should an economy’s ‘core’ prices – that do not include these volatile measures – remain strong, then that is cause for optimism, will fuel higher rate expectations and hopefully a stronger pound too.