18 October 2023: Wage growth slows to 8.1%

Average earnings fell to 8.1% in the three months to August but were above prices for the first time in two years. This suggests that the squeeze on the cost of living is beginning to ease.

The rate of increase was slightly lower than economist’s expectations suggesting that interest rates may have peaked.

Huw Pill, the Bank of England’s Chief Economist and a member of the Monetary Policy Committee spoke yesterday of his fear that wage increases are still too high, and this means that it will be difficult to bring inflation under control.

However, the fall in the pace of wage increases despite being smaller than Pill would have expected is welcome and is likely to accelerate going forward as the public sector pay round is concluded for this year and there is a sense in the private sector that inflation is beginning to fall.

Pill’s MPC colleague, Swati Dhingra spoke yesterday, and expects price pressures and wages to moderate further. She is considered more dovish than her more aggressive colleagues having voted for an end to rate increases at every meeting she has attended. She joined the MPC in September last year!

Furthermore, she feels that the fall in wage growth is indicative of a softening economy which shows that rates are now in a restrictive phase and no further rate increases are necessary.

Dhingra believes that inflation is no longer a purely domestic issue that can be brought further under control by tighter monetary policy. The time has come for greater concentration on promoting growth even if inflation remains stubbornly above the Bank’s target.

While it will draw accusations of moving the goalposts, there is a growing view that the inflation target may be too low as the era of low interest rates ends.

It would be brave of the Treasury to set a higher target for inflation in a global context although with a potentially damaging recession expected to hit early next year, a change in emphasis from fighting inflation to promoting economic activity may be due.

Today will see data published for both Consumer prices (CPI) and producer prices (PPI). PPI supplies some insight into future price pressures as it shows the cost of raw materials and parts “at the factory gate”.

Headline inflation is expected to have fallen to 6.5% from 6.7% year-on-year a month ago. That should be enough to encourage another pause from the MPC but could see Sterling weaken further.

Yesterday, the pound fell marginally against the dollar reaching a low of 1.2133, but it recovered to close at 1.2183.

Data published yesterday gave a mixed picture of the U.S. economy.

It is a market truism that investors should never underestimate the strength of U.S. consumers. So, it proved again as retail sales grew by 0.7% in September which despite being lower than an upwardly revised figure of 0.8% in August showed that shoppers are still the backbone of economic growth.

The data, when distilled to its various components showed that there is no one sector that is producing higher growth, and this may lead to an upwards revision in growth prospects possibly to as high as 4%.

The downside of this is that it is unlikely to drive inflation lower which may lead the FOMC to consider another rate increase at its meeting which takes place two weeks from today.

It seems that every time the soft landing is threatened, or the data predicts a slowing of headline inflation, the economy finds a way to correct itself.

A recession is still a possibility for the early part of next year, but it will take a sea-change in both the employment market and the behaviour of consumers for that to happen.

Austen Goolsbee, the President of the Chicago Federal Reserve spoke yesterday of his belief that the fall in inflation that has been seen recently is a trend and not a blip that should draw the attention of the FOMC.

Some of the data published recently shows that there is a persistence to price pressures that is somewhat unexpected, but Goolsbee agreed with Jerome Powell that it is unrealistic to expect the lowering of inflation to be linear.

Goolsbee wants to see the entire picture to decide on any further rate increases and cautioned on using a narrow set of numbers to determine changes in monetary policy.

The dollar is still reactive to events in Israel and Gaza. The President will visit the region today, beginning in Tel Aviv, where he will be briefed on Israel’s next move. He will then visit Amman and Cairo.

The dollar index is still quite volatile, rising to a high of 106.52, but ended the day virtually unchanged at 106.19.

There is still some debate about whether the ECB will consider that inflation is falling fast enough to allow it to pause the cycle of interest rates at its next meeting.

There appears to be growing support for a pause as several members of the Governing Council have been commenting that rates will likely stay “higher for longer”, and Christine Lagarde is now saying that she feels rates have reached the point where they are restricting demand.

In common with the United States, employment data is still strong in the Eurozone, and while the data has, in the past, proved to be unreliable, the trend is undeniable.

Along with strong employment data, wages are making it difficult for headline inflation to fall below 5% and given the hawkish tendencies of the ECB it may see little value in stopping rate increases having come this far.

Members of the Governing Council have been unequivocal in their view that there will be no pause in rate increases to allow the subject to be revisited “down the line”.

They want inflation defeated without any serious consideration of the possible effect on the economy. The feeling is that inflation is a more serious long-term issue than a few quarters of no growth or even a shallow contraction.

By and large there is wholesale agreement for this, and it is only the more indebted nations that are “squealing” as monetary policy tightens.

However, there is no reason to believe that despite the Central Bank expressing its desire to shrink its balance sheet that they will abandon economies that are severely affected by policies that are adopted for the benefit of the majority.

One problem that is appearing on the horizon is a gradual increase in wholesale gas prices and a return to the ninety dollars a barrel level in the oil price. Having seen inflation driven higher by higher energy prices last winter the entire Eurozone remains cautious about a repeat this year.

The euro is structurally weak, and its true value is around or just below parity with the dollar. It is still supported by the expectation that the ECB will not be able to cut rates until well into the third quarter of next year. Yesterday it saw an increase in volatility but overall, it remained within its recent range.

It rose to a high of 1.0594 but drifted lower to close at 1.0577.

Have a great day!