UK private sector wages rose in November by almost double the pre-pandemic rate – 6.5% compared with 3.8% – and yet the Bank of England is expected to consider the outlook for employment to be weak enough in the coming months to justify interest rate cuts.
The Bank’s monetary policy committee (MPC) meets next month to judge the health of the economy and whether interest rates at 5.25% are too much of a dead weight on households and companies.
It is a strange situation for the central bank to find itself in. In the US, the Federal Reserve is under similar pressure to cut borrowing costs, but that might seem more understandable in a country where wage growth has tumbled. The same situation applies on the continent, where the European Central Bank has never had a UK-style increase in wages.
Adding to the confusion is the huge variation in pay across various sectors. This is especially true in the private sector, which is most closely watched by the Bank as a barometer of the economy’s health.
Average weekly earnings including bonuses across the hospitality sector, including restaurants, hotels and bars, have risen 19.6% since January 2020, from £368 a week to £440, while inflation has grown by 21.7%. Meanwhile, wages have jumped from £699 a week in the financial and business services sector to £901 a week – a 29% increase since January 2020.
Both sectors experienced wages growth of 7% or more in November, while construction workers were held to just 4.5%.
The Bank of England believes annual wage rises should be about 3% to maintain a steady rate of inflation at 2%. Any higher, and wages would pressure on prices and push inflation up again.
So it is legitimate to ask why the Bank would consider cutting borrowing costs this year. Surely the wages data reflects a high demand for workers, which in turn shows the economy is running too hot and needs to be calmed down with higher, not lower, interest rates.
Until recently that was the view of three members of the nine-strong MPC, who voted for higher borrowing costs at the December meeting while their colleagues voted for a freeze.
In February one or two of the rebels are expected to reverse their position now wages are falling by more than the MPC’s 7.2% forecast for November.
The key to unlocking the next MPC vote is to look at where wages are going next.
Hannah Slaughter, a senior economist at the Resolution Foundation, said the data showed 2023 was “a year of two halves for pay packets, with strong growth in the first six months of the year, and barely any growth at all after the summer”.
She added: “This means that annual pay growth will continue to fall in early 2024 – and is no longer fuelling inflation.”
Financial markets expect this trend to mean five interest rate cuts this year, from 5.25% to below 4%. Whether all five happen this year hangs in the balance. But several cuts starting in May look increasingly likely.
