Slowing pay growth points to no change in interest rates

17 October 2023

The slowing in pay growth in August suggests that the MPC will keep interest rates unchanged at 5.25% again at its meeting next month. Admittedly, wage growth is still too high for the MPC to tolerate indefinitely, but wages tend to lag changes in labour market slack, which is continuing to accumulate.

Real wages rising strongly

Total wage growth across the whole economy fell from 8.5% in July to 8.1% in August, mainly due to a drop in bonuses. But private sector wage growth, excluding bonuses, also ticked down to 8% from 8.1%, indicating that pay pressures are slowly starting to ease. 

Just as importantly for households, real wages grew by 1.3%, the fastest rate since March 2022. That should boost to consumer spending a little in the fourth quarter and prevent the economy sliding into recession even if it contracted in Q3. 

But is the data unreliable?

There are concerns about the reliability of the ONS’ measures of labour market tightness and pay growth. The response rate to the ONS labour force survey has fallen sharply since the pandemic when researchers stopped going door to door to gather responses. The response rate currently stands at 14.6%, down from about 40% in 2019. What’s more, the ONS has found that the people most likely to answer a phone call from a random number during the day are those who aren’t working, heavily skewing the survey sample towards the unemployed and inactive. 

That said, the ONS remains confident in its previous estimates of the labour market, suggesting the recent leap in the unemployment rate isn’t just a statistical mirage and the labour market really is cooling. This, however, will add to the uncertainty facing the Bank of England. An MPC which is less confident in the data may decide to err on the side of caution though, which might make further interest rate hikes a bit more likely. 

The policy outlook

The crucial measure for the Monetary Policy Committee, though, is wage growth. And the ONS measure of that is likely to be much more reliable as it is collected directly from businesses, although even here the ONS measure looks like an outlier compared to most other measures. 

Indeed, the BoE has been trying to play down the strength in the AWE data. At the September meeting, policymakers looked past the big pay overshoot, while chief economist Huw Pill explicitly said earlier this week AWE data looked like an outlier.

Overall, the loosening in the labour market seems to be slowly feeding through into easing pressure on wages. That should satisfy the MPC that it just needs to be patient to see wage growth and inflation return to more normal levels, rather than resuming rate hikes.