Inflation Outlook – Sticky Wages?
As we head into the last data and rate decisions of 2023, with the Federal Reserve (Fed), European Central Bank (ECB) and Bank of England (BoE) all expected to hold rates, we question whether the current market outlook for inflation to moderate with central banks achieving a soft landing with the ability to start cutting rates in 2024 stacks up.
What is current market pricing?
As inflation prints have fallen back towards target globally, with energy base effects from 2022 dropping out and signs of an easing of demand in some sectors, markets have moved to price in several rate cuts in the US, Europe and the UK, starting from as early as next spring.
Markets are currently pricing cuts from the spring in the US, UK and Europe
Forecasts may not come to pass. Source: BlackRock, Bloomberg. Data as at 11 December 2023.
This is aligned with inflation pricing in the UK showing a continued fall into 2024, albeit likely not back to the 2% CPI target (just above 3% in RPI terms) until the middle of 2024.
Inflation path as implied by RPI Swaps
Forecasts may not come to pass. Source: BlackRock, Bloomberg. Data as at 11 December 2023.
This pricing in of some rate relief to come has led to a powerful rally in many markets, including equity and credit spreads. But is it too early to declare the war on inflation won? UK labour market data released in December by the Office for National Statistics showed year on year wage growth dropping to 7.3%, but there are still signs that the labour market remains particularly tight in the UK.
Decisions, Decisions
The BoE’s Decision Makers panel (DMP) is a key survey considered by the Monetary Policy Committee when setting monetary policy. It asks a variety of questions to almost 2,500 key decision markers in companies around the country on a range of topics, such as the outlook for their business and the labour market.
Two key questions it asks is for an outlook on likely price rises over the next 12 months and current rates of wage growth, as well as the outlook for wages over the coming year. On both measures, signs that the BoE will be able to significantly cut rates in 2024 look slim. On wage growth in particular, the outlook seems to be stuck stubbornly at 5%. This is a level of wage growth wholly inconsistent with inflation at 2% given productivity growth has been tracking below 1% for some time. Either wages need to increase more slowly, we need to see a jump in productivity or inflation can continue to trend above target.
Price expectations for the 12 months ahead are falling, albeit quite slowly
Source: BlackRock, BoE Decision Maker Panel Survey. Data as at November 2023. Realised price growth data are based on the question: ‘Looking back, from 12 months ago to now, what was the approximate % change in the average price you charge, considering all products and services?’ Expected price growth data are based on the question: ‘Looking ahead, from now to 12 months from now, what approximate % change in your average price would you expect in each of the following scenarios: lowest, low, middle, high and highest?’.
Wage growth expectations remain stubbornly above 5% for the 12 months to come
Source: BlackRock, BoE Decision Maker Panel Survey. Data as at November 2023. Realised wage growth data are based on the question: ‘Looking back, from 12 months ago to now, what was the approximate % change in your average wage per employee?’. Expected wage growth data are based on the question: ‘Looking ahead, from now to 12 months from now, what approximate % change in your average wage per employee would you assign to each of the following scenarios: lowest, low, middle, high and highest?’. Respondents were then asked to assign a probability to each scenario (values must sum to 100%).
Fiscal stimulus without the borrowing?
A key announcement that gathered less headlines around the time of the Autumn Statement was on the National Living Wage (NLW), which the Government confirmed would increase by 9.8%, to £11.44 from April 2024. This also included expanding its application to 21 year olds and up from 23 years and above previously. While this was in line with the low pay commission’s recommendations, it is still a material jump in the rate of pay for the 5% of the workforce who currently earn at this rate. We suspect this could have wider implications for salary rounds in 2024, with a significant proportion of the work force earning within £1-£2 of the existing rate. In fact, the Office for Budget Responsibility previously wrote in 2020 that they expect increases in NLW to impact salary brackets up to 40% above the level it is set at.
While a modest proportion of workers currently earn the NLW, many more earn within the bounds of the shift or close to the new level of £11.44
Source: Office for National Statistics. Data as at November 2023. Distribution of hourly earnings (excluding overtime) for all employees, from 2018 to 2023, UK (proportion of jobs within plus or minus 20 pence of shown pay rate)
Many employees will expect wage differentials to be maintained and with around 50% of employers still telling the DMP that hiring is harder than usual employers may feel compelled to oblige. This is likely to maintain pressure on wages more generally. It is interesting to note that the 5% year ahead wage growth expectations surveyed in the DMP were taken from responses made before this announcement on NLW was public.
Despite signs of conditions improving, UK labour market remains tight with around 50% of respondents still finding it a little or much harder than normal to recruit new employees
Source: BlackRock, BoE Decision Maker Panel Survey. Data as at November 2023. Question asked: 'Are you finding it easier or harder than normal to recruit new employees at the moment?'
What does this mean for UK Pension Schemes?
- Markets pricing the rate hiking cycle as over and significant cuts next year may be placing too little weight on sticky wage inflation and the continued strength of the labour market.
- With recent falls in inflation pricing this may present an opportunity to top up inflation hedges on a strategic basis.
- We continue to see merits in running a small structural under hedge in rates, particularly following the recent rally, given the two-sided nature of rate risks and collateral resilience risks generated by a move higher in rates if inflation persists and further hikes are priced.
- Uncertainty remains high on the path of inflation and rate cuts in 2024 – this is likely to continue to create dispersion and favour more dynamic approaches to managing hedges and instrument selection.
30yr inflation breakevens below the historic average when pandemic and post Brexit periods are ignored
The figures shown relate to past performance. Past performance is not a reliable indicator of current or future results. Source: BlackRock, Bloomberg. Data as at 11 December 2023. Swap breakeven inflation.
