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Wages and inflation - links, trends and forecasts

POSTED: 2nd June 2014
IN: General
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Wages and inflation - two highly important subjects for the UK economy and every consumer and business within it.

Wages and inflation - two highly important subjects for the UK economy and every consumer and business within it. Pay will often be at the forefront of workers' minds, but the average individual might not give as much thought to inflation - the rate of increase in prices for goods and services. undefined

There have been some significant trends in these areas over the past six years or so, resulting from the financial crisis, the recession and the recent recovery.

So how have wages and inflation changed over the past few years, and what can we expect in the future?

Wages and inflation during the recession

Like all aspects of the economy and life in general, wages and inflation underwent some dramatic changes during the financial crisis and the recession, particularly in late 2008 and throughout 2009.

According to data from the Office for National Statistics (ONS), the Retail Prices Index (RPI) - the measure of inflation that includes housing costs such as mortgage interest payments and council tax - plummeted from five per cent in July 2008 to -1.6 per cent in June 2009. This was followed by an upward trend that brought RPI to 5.3 per cent by April 2010. It reached a peak of 5.6 per cent in September 2011.

The Consumer Prices Index largely mirrored this volatility, falling from 5.2 per cent in September 2008 to 1.1 per cent a year later, before steadily increasing to reach 5.2 per cent again by September 2011.

These big swings were caused by several factors, including fluctuations in oil prices and the resulting changes in the prices of goods and energy bills, and alterations to the VAT rate in the UK.

The inflation trends seen over the last six years have put workers at a big disadvantage in terms of the value of their pay. According to the ONS, average earnings have gone up by 8.6 per cent since July 2008, but goods and services have increased in price by 16.9 per cent.

So what is the situation now?

The most recent statistics from the ONS offer more encouraging reading for workers and consumers. They show that, after six years of shrinkage in 'real wages', growth in average weekly earnings has finally caught up with inflation.

According to the data, weekly pay including bonuses was up by 1.7 per cent in the year to February, compared to a rise of 1.4 per cent in the previous month.

CPI inflation, meanwhile, was 1.7 per cent in February and dipped slightly to 1.6 per cent in March.

If bonuses are taken out of the equation, however, wages increased by 1.4 per cent in February, meaning the growth rate was still lower than inflation.

While there is certainly cause for optimism, it is worth bearing in mind that inflation-adjusted earnings are still some way off pre-recession levels.

Capital Economics, a macro-economic research firm, has said that real pay has dropped by a "colossal" ten per cent since the start of the financial crisis. This is thought to be the biggest decline in actual wages in any five-year period since the 1920s, BBC News reported.

What can we expect in the years to come?

Looking to the future, the picture is somewhat mixed. There is now a sense of optimism about the economy and business conditions, making it more likely that employers will have the capacity and inclination to raise wages, but there have been warnings that inflation-adjusted incomes will not return to pre-recession levels for some time yet.

According to the Office for Budget Responsibility, it will be at least 2018 before real earnings reach the point they were at in 2009-10.

There have been positive trends in the labour market regarding employment rates and hiring intentions, but pay continues to be a concern.

According to the latest Job Index from recruitment agency Reed, the number of permanent jobs available has increased by 21 per cent so far this year, compared to the 2013 average. However, the company's Salary Index is lower than when it was first set in December 2009, showing that wages have failed to keep up with rising living costs.

In a study released this month, the National Institute of Economic and Social Research said it saw "few signs of domestic inflationary pressures", in terms of both prices and pay.

The research body said wage growth in particular remains subdued and forecast that inflation will stay very close to the target rate of two per cent.

On the positive side, it appears that an increasing number of employers are showing a willingness to increase salaries.

A recent report from professional services firm Towers Watson predicted that wages will rise by an average of 2.5 per cent in 2014, which could result in net earnings growth of 0.4 per cent thanks to lower inflation.

Paul Richards, head of the company's data services practice in Europe, said: "Until this year the UK had consistently struggled with some of the highest inflation in western Europe and as a consequence, wage increases were having little impact on living standards.

"However, with inflation falling, UK employees may find that their pay rises go a little further this year. Healthy economic growth predictions for the UK may also prompt a sustained increase in salary growth over the coming years."

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