Will the UK economy avoid a price/wage spiral?

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EEF and JAM's Pay Settlements survey released today showed that the average Pay Settlement in manufacturing had edged up from 2.5% in the three months to April to 2.6% in the three months to May. This small increase suggests little evidence of inflationary pressures, rather settlements are returning closer to a level associated with normalising economic conditions.

With settlements remaining at close-to-average levels this should mitigate some of the other pressures that firms are facing such as commodity prices and global economic instability. This is in line with pay data released from the ONS last week showing that across the UK as a whole average weekly earnings rose by a muted 1.8%.

This is good news for the Bank of England, as it suggests that a price/wage spiral has not yet materialised. In fact, recent research from the Bank of England also shows that, on the whole, inflation expectations have remained relatively well-anchored. They also note that higher expectations of inflation are yet to feed through to wage or price setting.

Though the report does note that this assessment carries with it uncertainty, its conclusion is good news for the economy as a whole. The alternative scenario, with increased inflationary pressures, would mean the Bank had to raise interest rates, and this would hamper the growth that we sorely need.

But, with current CPI inflation running at 4.5%, below-inflation pay rises will mean that consumers continue to feel the squeeze.

This is highlighted by today's release of Markit's Household Finance Index. The index fell from 36.0 in May to 35.1 in June and is now at its lowest level since March 2009. Households' expectations for the next twelve months were also reported to have worsened.

The close-to stagnant labour market and faltering housing markets have played their respective parts in this dip in household confidence, but nearly all households expressed concern about inflation. Close to 90% of people surveyed expected their cost of living to rise in the next twelve months and consequently Markit's inflation expectations index hit its second-highest level on record.

The result is that consumers have become increasingly focused on value. Richard Hunter pointed out in the Guardian that:

Value food ranges are becomingly increasingly important as “the consumer concentrates more discerningly on the household budget”

As we saw during the recession, households are responding to this squeeze by substituting away from more expensive goods. This sort of behaviour should increase price competition and, what is more, it could ultimately bear down on the inflation consumers are experiencing.

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