Market Analysis

UK Inflation Slows, Undercutting Wage Growth Chatter (Again)

Wage growth follows inflation.

When the Office for National Statistics (ONS) announced wage growth surged to a record-high 7.8% y/y in the three months through June, you might think pay gains finally catching up with the inflation rate would be portrayed by commentators as giving consumers some relief.[i] But that wasn’t the case: Instead, as usual, commentators we follow warned rapid wages would entrench fast inflation, leading businesses to hike prices to recoup higher labour costs and so on in what economists call a wage-price spiral. This, commentators we follow say, means that although inflation has been slowing lately, it won’t last. Some publications we follow pinned UK stocks’ negativity early this week on this apparently grim reality.[ii]

The wage-price spiral is a very, very old theory—and one we think reality has disproved time and again. The US Federal Reserve (Fed), Bank of England (BoE) and many other major monetary policy institutions operate as if it is a foregone conclusion that wages drive inflation. This is why the Fed has a dual mandate of balancing unemployment and inflation—America’s Congress fell for what we think is a myth: that when unemployment is low, workers have more bargaining power to secure wage hikes, which drives inflation, whilst high unemployment reduces wage inflation pressures. Yet time and again, our research shows wages have followed inflation. To anyone familiar with American economist Milton Friedman, this isn’t a surprise. He argued—and showed—in the late 1960s that businesses factor in inflation when adjusting pay to compete for workers.[iii] Putting it another way, they compete on real, inflation-adjusted wages. Not nominal. If this weren’t true, high unemployment would have torpedoed inflation in the 1970s. It didn’t.[iv]

In our view, the aforementioned wage data provide more evidence. What happened a day after that record-setting wage growth hit the wires? Only the news that July’s inflation rate eased from 7.3% y/y to 6.4% when using the ONS’s preferred measure, the consumer price index including owner-occupiers’ housing costs (CPI-H).[v] (The more widely reported figure, headline CPI, also slowed—from 7.9% y/y in June to 6.8% last month.[vi]) This extends a trend of moderating inflation and accelerating wages that began last October, as Exhibit 1 shows.

Exhibit 1: Fast Wage Growth, Easing Inflation


Source: FactSet, as of 16/8/2023. Average weekly earnings excluding bonuses (rolling 3-month average) and CPI including owner-occupiers’ housing costs, year-over-year changes, December 2021 – July 2023. Wage growth data run through June 2023.

If wage growth caused inflation, this shouldn’t be happening. We think this shows there is no vicious circle of wages driving up prices, lather, rinse, repeat—just some long-awaited relief for consumers who seem to have weathered the brunt of a big cost-of-living storm. Not just from inflation and energy costs, but from a range of stealth tax hikes.[vii] We think wage growth finally passing inflation is likely to support continued spending growth from here, helping the UK gradually overcome an economic headwind.

In our view, there is a silver lining from publications we follow continuing to interpret wage growth as negative: It keeps a sentiment phenomenon we call the pessimism of disbelief alive, extending stocks’ wall of worry. Our research shows that when headlines couch good news as bad, it keeps expectations low, making it quite easy for reality to deliver positive surprise. This doesn’t preclude more volatility, in our view, but we think it points to UK stocks’ tough 2023 to date being a sentiment-driven correction (short, sentiment-driven drop of -10% to -20%), not the start of something more lasting and deeper.[viii]

[i] Source: FactSet, as of 16/8/2023. Inflation refers to broadly rising prices across the economy.

[ii] Source: FactSet, as of 16/8/2023. Statement based on MSCI UK Investible Market Index price-only return on 15/8/2023.

[iii] “The Role of Monetary Policy,” Milton Friedman, The American Economic Review, Vol. LVIII, March 1968.

[iv] Source: ONS, as of 16/8/2023. Statement based on UK CPI and CPIH, December 1969 – December 1979.

[v] Ibid. The consumer price index (CPI) is a government-produced index tracking prices of commonly consumed goods and services.

[vi] Ibid.

[vii] Source: FactSet, as of 16/8/2023. Statement based on NORX UK Power Daily Average and Dutch TTF Natural Gas spot price in GBP, 31/12/2022 – 16/8/2023 and “Jeremy Hunt’s ‘Stealth’ Income Tax Rise: Here’s How it Will Affect You,” Zoe Wood, The Guardian, 18/3/2023.

[viii] Source: FactSet, as of 16/8/2023. Statement based on MSCI UK Investible Market Index return, 31/12/2022 – 15/8/2023.

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