The MPC is using a recent slowdown in pay growth, as measured by average weekly earnings (AWE), as the latest excuse to defer a rate hike. This is likely to prove misguided, for several reasons.

First, the fall in annual AWE growth from a peak of 3.3% over March-May to 2.4% in the three months to October probably reflects a combination of lower average weekly hours and compositional effects, rather than a change of trend. Average hourly earnings rose by an annual 3.0% in the latest three months*.

Secondly, non-wage labour costs are rising rapidly – by 6.0% in the year to the third quarter, according to the experimental “index of labour costs per hour” (ILCH), with strength partly due to increases in sickness and maternity / paternity pay. Total hourly labour costs, therefore, grew by an annual 4.0% last quarter, up from 1.8% a year before – see chart below from the ILCH release.

Thirdly, a focus on current pay ignores coming upward pressure on labour costs from the introduction of the national living wage and the “apprentice levy” payroll tax.

Fourthly, the labour market continues to tighten: the single-month unemployment rate fell to 5.1% in October versus a fourth-quarter forecast of 5.3% in the November Inflation Report, while the stock of unfilled vacancies rose to another record in the three months to November.

Finally, current pay trends need to be assessed in the context of near-zero inflation. A rebound in the latter in 2016 will ensure upward pressure on AWE growth even if the labour market stabilises or softens.

Increased labour cost growth, in other words, is likely to accompany rather than lead a pick-up in inflation. Economists learned that wages were an unsuitable intermediate policy guide in the 1970s; the current crop of central bankers seems to have forgotten the lesson.

*AWE growth of 2.4% adjusted for a 0.7% fall in average weekly hours worked reported by the Labour Force Survey.

Source: Office for National Statistics