XpertHR economic overview February 2014: Why pay could prove pivotal to economic recovery

UK economic recovery appears to be well underway in 2014, but strong growth in pay awards could be required for a truly sustainable return to growth.

XpertHR’s economic commentary for February 2014 reports on latest data and expected future trends in key economic indicators of direct relevance to HR professionals and reward specialists, including pay awards and pay forecasts, inflation, economic growth and labour market trends.

Why pay is pivotal in 2014

Pay always matters. It will matter even more than usual in 2014 when it will determine not just the fate of the UK’s economic recovery but conceivably the result of the next election as well.

So says the Guardian’s Larry Elliott. “Companies have got used to having the upper hand in wage negotiations,” as a result of UK workers’ willingness to accept lower pay awards during the recession. He argues that employers should now consider higher pay awards in order to underpin consumption, investment and a sustainable recovery.

XpertHR’s Sarah Welfare notes that “there is likely to be considerable pressure on employers from both trade unions and the Government if both the economy and labour market continue to improve and higher pay rises do not materialise.”

Pay awards will consequently represent one of the most closely-watched indicators of the strength of economic recovery in 2014.

Pay awards still stuck at 2%
Pay awards remained subdued at the end of last year, according to latest readings from the XpertHR pay databank:

  • The median whole-economy pay award held at 2.0% over the three months to 31 December 2013. The median pay award has now been stuck at this level for each rolling quarter since April 2013.
  • “A look back over the 2013 calendar year confirms that pay settlements were slightly more subdued than they were in 2012,” Sarah Welfare comments.

Will the trend for subdued pay awards persist in 2014?
We could see a rise in the value of private-sector pay awards in 2014, XpertHR research suggests:

However, ongoing Government pay restraint is in store for public-sector workers in 2014.

Above-inflation national minimum wage increase in prospect for 2014/2015?
Chancellor George Osborne has recommended that the independent Low Pay Commission (LPC) recommend an above-inflation increase to the national minimum wage for 2014/2015.

There is speculation that Osborne would like to see the national minimum wage adult rate increase to around £7 per hour by 2015/2016. This would represent a significant rise from its current level of £6.31 per hour for 2013/2014.

Some employers’ organisations argue that an above-inflation national minimum wage increase would be unaffordable. But such an increase to the national minimum wage could be politically expedient for the Coalition Government in the run-up to the 2015 general election, while also helping to tackle the looming welfare crisis, says the FT.

The LPC is expected to publish its national minimum wage recommendations for 2014/2015 in the Spring. The national minimum wage rates for 2014/2015 are expected to come into effect from Wednesday 1 October 2014.

Average earnings growth remains weak, despite public-sector rise
Public-sector total pay has returned to growth after falling over recent months; but overall, average earnings growth remains subdued across the UK economy, latest ONS data reveal:

  • Whole-economy total pay (average weekly earnings including bonuses) rose by 0.9% over the three months to November 2013.
  • After falling over recent months, total pay in the public sector (average weekly earnings including bonuses) rose by 0.2% when compared with a year earlier, while total pay in the private sector rose by 1.2%.
  • Average weekly pay in the public sector (at £488) remains higher than in the private sector (£472).
  • Whole-economy average regular pay (average weekly earnings excluding bonuses) rose by 0.9% between September and November 2013.

Average earnings outlook: ‘No risk of serious wage inflation’ in 2014?
“2014 will feel like yet another year of relatively slim pickings” for average earnings growth, says economist John Philpott.

Philpott expects earnings growth of 2.4% in 2014, “moderated by the still high rate of unemployment and public-sector pay constraints.” Therefore, while earnings growth may finally overtake inflation towards the end of the year, “there will be no risk of serious wage inflation in 2014.”

Many commentators think we will see improved earnings growth in 2014; but there is disagreement as to how fast and by how much earnings might grow:

  • BCC: “Earnings growth will edge up slowly, but will still stay below inflation in the next few months. Real earnings will only move into positive territory in the final months of 2014.”
  • The EY ITEM Club expects average earnings growth of 1.8% in 2014 (unchanged from the earnings growth rate for 2013, but in line with its forecasts for CPI inflation in 2014).
  • Duncan Weldon, TUC: “Hopefully real wage growth should return by the middle of 2014. However, even when it returns, real wage growth looks set to remain weak for years to come. On current trends it could take until end of the decade for real median wages to return to pre-recession levels.”

Inflation: CPI falls to 2% target; RPI rises
Latest official inflation data from ONS are a mixed bag, with CPI inflation (the Government’s preferred rate) falling, while RPI (the inflation measure most commonly used by private-sector employers in pay setting) rose:

  • Retail prices index (RPI) inflation rose to 2.7% in December 2013, up from 2.6% in November.
  • RPI is 0.7 percentage points above the 2.0% headline pay award as measured by XpertHR.
  • Retail prices index using the Jevons formulation (RPIJ) inflation held steady at 2.0% in December 2013.
  • Consumer prices index (CPI) inflation was 2.0% in December, down from 2.1%. This is the lowest rate of CPI in more than four years. It is also the first time that CPI has exactly hit the 2.0% target rate since November 2009. The fall in CPI was primarily due to slower growth in food and drink prices.
  • Consumer prices index including owner-occupiers’ housing costs (CPIH) inflation was unchanged at 1.9%.

Inflation to stay ‘cool’ throughout 2014?
Inflation is expected to remain comparatively subdued over the coming year:

  • Capital Economics: “CPI inflation looks likely to spend more time below the 2% target than above it in 2014, helping real earnings to finally recover.”
  • EY ITEM Club: CPI inflation will average 1.8% this year (“assuming that oil prices remain at $110 a barrel or below”), rising to 2.1% in 2015 and 2.4% in 2016.
  • Sunday Times Economics Editor David Smith: “Inflation is set for a prolonged period of on-target, or even below-target inflation. […] Suddenly the air has gone out of the inflation balloon.”

UK economy grew by 0.7% in Q4 2014
The UK economic recovery continues apace, with continued strong growth in the closing months of last year.

The UK economy grew by 0.7% in the fourth quarter of 2013, according to preliminary estimates on growth in gross domestic product (GDP) from ONS. This compares with latest revised estimates of 0.8% GDP growth in Q3 2013.

Over the course of 2013 as a whole, UK GDP growth came in at 1.9%, in line with US GDP growth for 2013.

UK GDP outlook: Is UK GDP growth set to roar ahead in 2014?
Here is XpertHR’s latest monthly round-up of GDP forecasts:

  • The BCC thinks UK GDP “will grow by at least 2.7% in 2014, almost double the growth in 2013. The recent rapid pace of expansion will moderate after the first quarter.” However, “GDP growth in 2015 will be lower than in 2014.”
  • The EY ITEM Club forecasts UK GDP growth of 2.7% in 2014, falling back to 2.4% in 2015 and 2.3% in 2016.
  • The IMF has upgraded its forecast for UK GDP growth in 2014 from 1.9% to 2.4%.
  • James Knightley of ING thinks “the economy can post GDP growth of 3% this year.”
  • Andrew Smith, KPMG: “Growth will accelerate to 3% plus. Surging consumer confidence and the recovery in spending indicate households are already feeling better off.”

UK labour market goes from strength to strength
The UK labour market is in rude health, with unemployment falling sharply, according to latest ONS data:

  • The headline unemployment rate (on the ILO definition) fell to 7.1%, down by 0.5 percentage points from the previous rolling quarter.
  • The number of unemployed people fell by 167,000 over the three months to November 2013, to 2.32 million.
  • The total number of job vacancies rose by 22,000 to 569,000 over the three months to December 2013.
  • The vacancy rate stood at 2.1 vacancies per 100 employee jobs over this period.
  • Output per worker rose by 0.1% between the second and third quarters of 2013.

However, rapidly falling unemployment is problematic for forward guidance.

The Bank of England announced in August 2013 that under its new forward guidance policy, it will not review the level of interest rates until unemployment falls to 7%. It has now acknowledged that unemployment is “likely to reach the 7% threshold materially earlier than previously had been expected.”

There is speculation that the Bank of England will amend its forward guidance strategy in its quarterly Inflation Report later this month. Bank of England Governor Mark Carney has indicated that forward guidance could be amended to take stock of “overall conditions in the labour market.” Many commentators are calling for the threshold unemployment rate to be dropped to 6.5% or lower, while some also wish to see the addition of an earnings growth threshold.

Labour market forecasts: Unemployment to fall below 7% threshold this year
The UK labour market is set to remain strong in 2014, with unemployment likely to fall below the 7% level this year, XpertHR’s latest monthly round-up of labour market forecasts finds:

  • The EY ITEM Club expects unemployment to “fall below 6.5% by the final quarter of this year, but we think the MPC will wait for the recovery to strengthen before increasing base rates. We have penciled in the first base rate increase for the third quarter of 2015.”
  • James Knightley of ING thinks “there is a clear threat that the 7% threshold is breached in the next month or two.”
  • John Philpott: “The level of unemployment is forecast to fall to 2.3 million (7%) by the end of the second quarter.”

However, unemployment may have to fall much further before we see stronger earnings growth, argues economist David Blanchflower. He says: “Wages are unlikely to rise much until the unemployment rate approaches full employment which in my view is likely to be below 5%.”

A truly sustainable economic recovery may yet be some way off.

See also:

  • XpertHR Benchmarking Find out more about XpertHR’s unique interactive HR benchmarking data service.

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