Soaring earnings growth not as good as it looks - Capital Economics
UK Economics

Soaring earnings growth not as good as it looks

UK Economics Update
Written by Thomas Pugh
Cancel X

The surge in average earnings growth to a ten-year high is not what it seems as it’s partly due to large numbers of lower-paid workers losing their jobs. As such, the upward pressure on inflation from earnings growth is much smaller than implied by the headline earnings data.

  • The surge in average earnings growth to a ten-year high is not what it seems as it’s partly due to large numbers of lower-paid workers losing their jobs. As such, the upward pressure on inflation from earnings growth is much smaller than implied by the headline earnings data.
  • The labour market is having a pretty good crisis. The unemployment rate has “only” risen from 4.0% in February to 5.1% in December due to the furlough scheme. And the headline three-month average annual earnings growth rate (3myy) increased to 4.7% in December. That’s the fastest rate since 2008. And we suspect it may rise to over 8% in the summer this year, the fastest since the early 1990s! Some of the further rise this year will be partly due to the level of earnings being compared to when it fell last year. (See Chart 1.) But some of it will be due to the changes in the composition of employment that have already boosted earnings growth.
  • As more low-paid workers are losing their jobs than high-paid workers, average earnings per employee increases even if no-one actually receives a pay rise. Indeed, the job losses so far have been concentrated in low-paid sectors like accommodation and food services (50% of job losses) and retail (20% of job losses), where the average pay was half, and three-quarters of the UK average respectively. And within those sectors, the job losses seem to have been concentrated amongst lower earners. For example, more waiters have become unemployed than restaurant managers. Indeed, full-time employment, which tends to pay a higher hourly wage than part-time employment, has only fallen by about 30,000 since January compared to a drop of about 560,000 for part-time employment.
  • The ONS estimates that the effect of these compositional changes to the workforce boosted headline 3myy average earnings by about 2.8 percentage points (ppts) in December. This would mean that underlying earnings growth was about 2.0%. That would put it more in line with other measures of wage growth such as median pay settlements. (See Chart 2.) As lower-paid people continue to lose their jobs at a faster rate than higher-paid people, these compositional effects will probably continue to push earnings growth up over the rest of this year. (See Chart 3.) Indeed, the compositional effects combined with base effects could push earnings growth up to 8.5% in June. But once employment growth starts to rise again, the compositional effects could drag earnings growth down below 2.0% 3myy in 2022.
  • Of course, it’s the change in the actual amount paid out in wages that matters for firms’ costs and CPI inflation. Due to the compositional and base effects, earnings growth is exaggerating the upside risks to CPI inflation. We think services CPI inflation is more likely to return to between and 2.0% and 2.5%, rather than soaring to almost 4.0% as suggested by earnings growth. (See Chart 4.)
  • This isn’t enough to cause us to revise down our inflation forecast. After all, a rise in inflation from 0.6% to 2.5% by the end of 2021 is largely baked into the cake due to previous rises in commodity prices and the expiry of tax cuts. But it does support our view that there is a great deal of spare capacity in the economy, which will drag inflation back down to 1.0% in 2022 and prevent the Bank of England from raising interest rates above 0.10% for the next five years.

Chart 1: Average Weekly Earnings (£)

Chart 2: Average Earnings & Pay Settlements

Sources: Refinitiv, Capital Economics

Sources: XpertHR, Refinitiv

Chart 3: Average Earnings

Chart 4: CPI Inflation & Average Earnings

Sources: Refinitiv, ONS, Capital Economics

Sources: Refinitiv, ONS, Capital Economics


Thomas Pugh, UK Economist, +44 (0)7568 378 042, thomas.pugh@capitaleconomics.com