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Fundamental changes in the labour market? HL comment

Ben Brettell, Senior Economist, Hargreaves Lansdown:

The squeeze on real incomes continues, with pay growth still hovering around the two percent mark while inflation runs at three percent. Meanwhile unemployment remains at a multi-decade low of 4.3%.

The big question for economists is when the tightness we are seeing in the labour market will eventually feed through to higher wages. The Bank of England says this should happen next year, but I don’t think it’s a given.

In theory, with unemployment so low, sooner or later demand for labour will outstrip supply and workers will be able to demand higher wages. But it looks like something fundamental has changed in the labour market, allowing wages to remain depressed despite low unemployment. Perhaps technological developments and global competition has weakened the bargaining power of the worker. A report this week from the Chartered Institute for Personnel and Development (CIPD) said employees weren’t pushing for higher wages even though unemployment is low.

The underlying problem remains one of productivity, which is the only sustainable driver of real wage growth. In this respect the UK continues to lag behind its developed-world counterparts, notably the US and Germany. Economists and governments have tried – so far in vain – to find a solution to this productivity puzzle.

Light at the end of the tunnel

Ultimately the pay squeeze could be ended by falling inflation, rather than an acceleration in wage growth. Yesterday’s numbers undershot expectations with CPI inflation holding steady at 3.0%, and showed slower rises in the costs of raw materials and prices at the factory gate. This could be a sign the inflationary spike is close to an end. We should see price rises start to slow over the next twelve to eighteen months, as the effect of the weaker pound begins to recede.