Monthly Archives: April 2015

Wages appear to beat inflation, but not when correctly lagged

The declining unemployment figures were such good news today, that most commentators appear to have overlooked reporting the data that ONS also published on wages.  These show average wages in February were up 2.2%, a figure significantly ahead of the latest published inflation figures (RPI=0.9%, CPI=0%). It is therefore very tempting to think wages are now increasing much higher than inflation and that the slack in the economy may have been extinguished. As ever with statistics there is much more to this than first appears. Although wages have picked up in the last year, workers have probably not yet negotiated better deals than inflation.

The complexity comes about because the wage bargaining process takes time and therefore has used a historical inflation benchmark as its reference point. The process of deciding on wage increases through to their implementation can take companies three months (or in the case of the public sector, more than double this time). For example it is likely that many of the wage increases included in the latest data today were actually decided looking at inflation figures from last autumn. It is therefore important to look at a lagged indicator of inflation in comparison to the ONS wage data.

The chart below therefore compares the rises in wages published by ONS with a lagged inflation figure. To make the data comparable, I have lagged inflation by six months, i.e. the latest wages figures (February 15) are being compared with what inflation was like in August 14. You can argue over the precise lagging, but this seems to fit the data quite well.

For inflation I have taken RPI as this most accurately reflects price rises experienced by people (see here for problems with CPI). RPI is also the main benchmark used in the private sector still.

wages v inflation

What is interesting about the graph is it shows that in “normal times” – say in the 4 years prior to the 2007 recession, wages exceeded RPI inflation by about 1% . This is in stark contrast to the first four years of the collation (2010-2014) where they lagged RPI by an average of 2.4%.

All this started to change about a year ago. Since then, wages have started to catch up the lagged inflation measure. It remains to be seen if they manage to exceed it longer term. There are two scenarios here.  The first assumes the slack in the economy has been used up and we return to normal 1% premium i.e. point A by the end of year, i.e. wages about 2% up in December 2015.

The second is that the latest data is somehow more of a pre-election effect brought about by a short-term borrowing and housing stimulus. In which case wage rises may decline back to near-zero levels by the end of the year as the impact of recent headlines of zero inflation rates take their toll on wage bargaining. i.e point B.

However what is key to note though is that the simple graph published by ONS is implying that wages are exceeding inflation by nearly 2% is misleading. That is just wrong because of the lagging effects and also their usage of CPI which is always about 1% lower than RPI.

ONS wages

Latest UK inflation data – April 2015

The latest inflation figures today show that average prices were unchanged again in March as measured by CPI. However the average very much hides a game of two halves.

What is causing CPI to be so low is the impact of declining energy and food commodity prices together with a supermarket price war. Although petrol prices rose a few pence last month, they are still 14% lower than a year ago. Food overall is down 3.2%. Both of these are contributing to making CPI almost 1% lower than it would otherwise be.

However it is the goods vs services split that reveals most about what is going on with UK prices. Goods are down 2.1% while services are up 2.4%. Below are some examples of the price rises we are seeing in services. Some are in regulated areas, where governments have an interest in helping stoke inflation – see discussion here. However most of them are in discretionary areas and it is possible that some companies are taking advantage of the increased spending power caused by lower food and fuel prices to increase their charges.

  • 10% Education
  • 5% Transport (especially planes)
  • 3% Hotels
  • 3% Recreation and culture
  • 3% Domestic services
  • 3% Gardening
  • 3% Hospital services
  • 2% Restaurants
  • 2% Car repairs
  • 2% Papers/magazines

In addition to the above, it should be remembered that tax rises have increased tobacco costs by 8% and house prices also rose 8% – although this is excluded from CPI (see discussion here).

Indeed underlying inflation, although declining, is still 1% and it is quite likely that inflation in the UK will be heading back towards 2% by mid-2016 when the recent commodity price drop out of the calculation early next year. Inflation is not dead yet in the UK as some politicians might want to suggest. Having said that, the outlook for inflation for the rest of the century could well be subdued – see discussion here.

More details on the numbers can be found in the full ONS report.