Growth shines as Bank of England continues wage debate

UK economy watchers will have looked over last week’s run of data and offered a gentle nod of admiration to a job well done.

The highlights were the Bank of England minutes from the Monetary Policy Committee’s meeting earlier this month, and the provisional release of Q2’s GDP figures, coming in at 0.8% for the quarter. From these announcements it is clear to see why the IMF decided to amend its forecasts of UK growth to 3.1% through 2014 – the highest in the G10.

The Bank of England minutes revealed further conjecture about the juggling act they are having to manage. We have an economy that is growing strongly, but it is lacking some crucial attributes that policy makers want to improve before moving interest rates higher. The most important of these factors is the relationship between wages and the newfound strength in the UK labour market.

The MPC would not have had the latest wage data when deciding policy this month and the decline in wages, excluding bonus payments, fell to 0.7% in the three months to May. With CPI currently running at 1.5%, the run of real wage declines doesn’t look likely to end just yet. Members of the Committee were split into two groups when trying to explain why an economy strengthening at the rate that the UK’s is would be seeing very weak wage growth.

Some members believe that there is simply a lag between people coming into the labour market and wage increases, others see a deeper structural change in the labour market that has taken place.

We are in the first camp, but acknowledge that there has also been issues around the supply of labour as well. Unemployment is all about lags. At the first signs of a slowdown companies don’t tend to start firing people right away; they will cut costs, retrain and evaluate performances before showing someone the door. We see a lag between growth falling off and the unemployment rate rising and vice versa when the economy improves. Employers will ask workers to do a couple more hours, or work weekends and will then start to expand payrolls.

Where wages come in is when employers begin talking about workers who are suitable for the role. As those who have been jobless for longer lose skills, their ability to organise higher wage settlements falls. As the global financial crisis and the recession continued, the number of long term employed reached near-record levels in the UK. As they’re coming back into the jobs market they are indeed bringing the unemployment level lower but, without the subsequent run higher in wages.

We have spoken about slack in the UK economy for long time now, but as this slack in the jobs market is taken up, then wage settlements and subsequently inflation should come higher.

As far as actual interest rate policy is concerned, there is once again two groups within the MPC. While one side is happy that risks of a rate rise to the recovery have receded, others believe that a “premature tightening in monetary policy might leave the economy vulnerable to shocks.” We will get a better look at what the MPC thinks at the Bank’s August Inflation Report, due August 13th.